jonathan: from new york city for our audience worldwide, i'm jonathan ferro. bloomberg "real yield" starts right now. ♪ jonathan: coming up, closing out a chaotic august, following a big month for government bonds. growth anxiety lingering with another round of tariffs set to hit next month. president draghi facing down the european central bank horse. we begin with the big issue, a month to month for government debt. >> you have a big rally. >> huge rally in the bond market. >> huge inflows, one-sided trade. >> insatiable demand for yield.

>> the message is things are slowing down. >> growth is slowing everywhere. >> the fed is not cutting fast enough to keep up with the falling growth outlook. >> they are actually behind the curve. >> the market is crying out for more. >> we are looking at extraordinary times in bond markets. jonathan: joining me from london is james athey. in new york, greg staples, priya misra of td securities. priya, what a month it's been. the 10 year treasury, people forget, 2% feels like a lifetime ago. it was the end of july, and we are down near 1.50. priya: i think it means it is month to month for the entire rally, but what is also interesting, the curve steepening. we have had the 5-30 curve steepen out since the middle of last year. that also flipped in august. this was a bull flattening rally.

this is the month where investor confidence in the trump put and fed put were shaken. the last 300 billion of tariffs, a lot of people expected the president would not initiate tariffs on that because it would have an impact on the consumer. that happened in august. then we hear from fed officials and they are not talking about easing significantly. even if they were, it is not an interest rate problem. it is not even clear if the fed cut they could offset all of 20 this global growth uncertainty. jonathan: you have touched on several important things. james, many people came into august looking for a bull steepener, looking for yields to drop at the front end big time. they got a drop of 50 basis points on 10's, and a similar move on 30's. is there anything that you can assign a higher probability to that will change that trend

anytime soon? james: high probability is difficult. you are talking about inflation shock or the fed gets very aggressive on monetary policy. the conversations we are hearing from regional said presidents, fed governors, it feels a bit too in denial about how serious the economic outlook is, and don't seem to be recognizing the troubles we are likely to see at the front end. because it's a committee and the be a consensus driven organization, 50 basis points or more at the september meeting seems unlikely. for now, i think the curve will stay flat. i still like the steepener, i still like to own the front end, but i think it will take another hawkish mistake, shall we call it, from the fed in september for them to realize the pickle they got themselves into. jonathan: what is to like about a steepener right now? james: good question. in terms of the carry at the

front end, it doesn't look great. in terms of the value, it does look good. it is difficult for the curve to aggressively invert in this type of scenario. i can understand why it may flatten and get to zero, but in terms of moving dramatically beyond that it's very difficult, whereas there are number of outcomes were we could see the front end outperform. gregory: we have had rallies in years past but nothing so data empty as this one. this is all been anticipatory. at this point, a lot of august was momentum. it was algo driven. we were running on fumes. it would not surprise me to see a selloff in september, particularly as we get into the central bank actions, the ecb, the fed on the 18th. we've talked about this before. what happens next friday if we get a strong jobs number? how does the fed react to that? you have heard a couple members say they are reluctant to use in -- to ease in july, and now you

are calling for them to ease again in september? that could shock the markets. jonathan: what led to the steepening was secretary mnuchin , the treasury secretary coming out saying that he is still considering ultralong bond issuance. this is what the treasury borrowing advisory committee said in may of 2017. we have talked about this so many times. this is what they said, ultralong's are most likely to be demanded with those with longer dated liabilities. the committee does not see evidence of demand beyond 30 years. of course, what matters is what the curve looked like then versus what it does now. it is a radical difference. but will the advice be any different this time around? priya: there is demand for the long end but there is not a lot of demand at current levels, below the 30 year points, from this community. they will still say the same thing, the treasury does not have to follow the t back. the treasury clearly wants a

steeper curve. everybody wants a steeper curve. we would all benefit, banks would benefit in a steeper curve. they can try to steepen the curve by issuing, but i don't know that it is the lowest cost to the taxpayer. how much more are they going to keep issuing? is the demand going to be there at the second, third auction? they would have to issue a lot. is the data strong enough? i think that will dominate. supply can be a knee-jerk steepening. i really don't see this captain -- captive demand that is waiting to buy these long and treasuries. jonathan: typically, we look at borrowing costs on the 30 year south of 2%. all-time lows. to 50, t they go long, 100?

what the market has gotten so used to is the predictability of size, a certain maturity, every single quarter. is that what we are sacrificing, james? james: whether or not that is a good thing, i don't know. you are getting into different areas, experiences we have had in the past where predictability lays down the foundation for shocks essentially. essentially, things cannot remain constant. the idea of steepening the yield curve for the sake of it, i struggle. if you go back far enough, the fed wanted to flatten the yield curve in order to stimulate the economy. what i care about is what is going on underneath all of this. that is why i like to push back on the notion that we have not seen data to justify the rally. essentially, ifn's in the u.s. have gone from 60 to 50 in an unblemished line. we have seen headline payrolls grow slow, -500,000 jobs revision to the payroll reports from march to march. we've seen the working week in the manufacturing industry declining precipitously. if you look outside of the u.s. borders, china is no longer the

supplier, the commander -- demander that it was, and that has brought the eurozone down. it looks like economies have gotten considerably weaker or absent the u.s. consumer. when they start losing their jobs, and there is early evidence that is about to start happening in more stinking of the -- more significant size, then that is when his start to feed off of itself in a negative fashion. for me, the data is what is most important, and that has justified a treasury rally. gregory: i don't think we see the data. we have seen it in manufacturing but look at retail sales this week. look at the employment. we are at 50 year lows for unemployment. i would rather the fed hold onto its ammunition, wait until they see a payroll spread that is double digits rather than triple digits and then react. right now i think it is too soon and they are hearing footsteps. jonathan: the treasury market has been defense and -- defensive. we have seen the bull flattening come through in august. what has also been interesting is what is happening in credit.

very defensive. a flight to quality, investment-grade having a fantastic august. bb's outperforming ccc's. is that a new trend we should get behind? is that something we should get behind? priya: i think we should. it is different from the fourth quarter of last year. i read that as a policy mistake. maybe investors are worried about u.s. growth. if you look at the data front, the manufacturing sector is weak, but we have not seen evidence that this is flowing into services. we have seen global growth data being bad, but the u.s. economy is a largely closed economy. so the question is is that filtering into u.s. gdp? i think what investors are saying, maybe we should look at that quality trade. they are buying treasuries, higher grade corporate, also buying the defenses in the equity market. all in all, you are seeing this active management coming back. that will only extend because global growth looks weak and trade uncertainty is here to stay.

we should be getting behind that and we should be loading up on quality here. jonathan: james, is that an argument that resonates with you? james: i agree with priya. i think essentially what we've seen is essentially you don't go from zero to hero in one step, you don't go from hero to zero in one step. we are seeing the internals of risk facing markets, they are been shown for some time to trend toward more defensive approach to investing. we are seeing in the corporate bond space, suddenly the quality of the balance sheet is one of the things that is most important that will determine which names you choose. definitely a signal there. you also have to recognize the structure of the markets, the liquidity that has been thrown in by the fed and global central banks. that money has to go somewhere. in a yeley -- low yield environment, those investors that can take on the liquidity risk, they have chosen to do so. that has slightly shifted some of the signal value that you

get at this early inflection point in the cycle in terms rather than the outright level of spread. i think it's a more accurate forward-looking indicator. jonathan: james athey sticking with us alongside greg staples and priya misra. coming up, the two-year treasury auction drawn a yield above the 10 year for the first time since 2007. that conversation around the corner. 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 the united states, where the treasury sold $40 billion of two yield notes at a yield of 1.56%, the lowest since 2017. the first time in 12 months the two year yield yielded more than

the current 10 year note. unbelievable stuff. likewise in europe, germany sold more than 2 billion euros of 10 year notes, where investors offered to buy nearly two times the amount of the securities sold. solid demand despite the record low average yield. italy selling 4 billion euros in 10 year notes this week, the average yield on the 2030 bond fell to an all-time low of 0.96%. let's stick with italy. italian bond yields can go even lower. >> we are long the italian market relative to germany. we have more spread now than a month ago, so it's an attractive opportunity. italy is something you have to look at tactically. you know it trades in a range. we are now in the top end of that range. we think it's a buying opportunity as a result. jonathan: let's have that conversation. james athey, greg staples, priya misra still with me. is that a trade you can get behind? james: how did i know you're going to come to me on that one?

i struggle. i appreciate and to some degree agree with the bullish arguments with respect to btp's, i just cannot help seeing the potholes in the road ahead. it is a very tricky situation in -- that italy has to do with, economically, socially, politically, and as a part of this monetary union which is starting to exhibit some stresses which concern me. the ecb is ready to come in and take away all the credit risks they see in the system. but if you look where btp's are trading already, it feels like the downside is bigger than the upside. i cannot step in front of the train right now. the front end and started to look more interesting. if you go back a few months, you want to be short two-year btp's. 45 a yearst you alone. that has flattened out now and it is three or four basis points. when there is a credit fear, the front end blows out. i have my eye on that.

i don't have a position on the front end right now but i cannot be a blind bull on italy. jonathan: greg staples, nobody wants to be a blind bull on italy. i know that when it drops below year,the italian 10 people say, what is going on? a look at the spread of the italian 10 year versus the german ten-year. in the spring of 2015, 88 basis points. we are at 171 now. i know people think we can test those highs once again. gregory: it is all about politics. looks like we have a coalition between five-star and the pd. there will be a bit of a honeymoon, the rating agencies will bless the investment grade, but longer-term, they will try to break up the government. they have a difficult budget ahead of them in 2020. they will look to come up with a deficit. i think the coalition is under some stress. longer-term i would be wary. near-term i think we can get as tight as 110 the bund.

two jonathan: you have to make a call on the government. is it a credit or self risk? -- credit or sovereign? that is what divides a lot of people. does it behave as a credit or sovereign security? priya: right now it behave like a sovereign. draghi in 2012 came in and said i do what it takes. i think you'll hear that again. we not talking about the breakup. italy is almost too big to leave the eurozone. it should act as a sovereign. i'm also going to highlight, the ecb is also about to do qe in the next two weeks. i think they will start buying. that spread widening, it is the widest spread. for the japanese investor, fx hedge, italy is the only sovereign bond market that gives them anything more than jgb's. they will be buying. i think you need no ratings action, we need the government to hang in. how many elections have we had in italy the last 10 years?

we have to live with that political risk, but right now as we look for yield, as the ecb is coming in, we should be looking for that spread to compress. it should trades like a sovereign. jonathan: let's talk about the ecb doing qe. the hawks lining up throughout the week. all pushing back not against rate cuts, but pushing back against the prospect of more qe. will their voices be heard next week? priya: i think they will be heard but i think the doves will outnumber them. if you look at what has happened since july until now, the last meeting, all the data has been worse. we just got inflation. it is hard to move that higher. inflation expectations have decelerated. everything the ecb had been looking at has worsened. even though the divide is there in the ecb, as it is in the fed, if you look at the data, i think

they will have to ease. the question is can they ease a lot on the rate front? maybe -75, -80 basis points may be the level which the ecb should not cut anymore. then it becomes counterproductive. so what do they do? they cut 80 basis points and then they cannot say that we are out of bullets, which is why we think they will have to do qe. jonathan: basic case for the ecb september 12? gregory: i think they will ease. i think their policy has been a disaster. they are hollowing out their insurance companies, they are making it difficult to fund pensions. they should stop doing that. but i think they are going to. let's talk about, what is their objective with quantitative easing? you have 10 year bunds at -70. 10 year italian bonds at plus 90. ig barely over 25. what are they trying to accomplish? 25 basis points on euro denominated investment

debt. quite remarkable stuff. greg staples, priya misra, james athey staying with us. coming up, we will be talking about china and tariffs. what a month and week it has been. treasuries, not a massive move, down a basis point. 1.52 on the 10 year. it is the moves on the month that matter. huge moves on 10's and 30's. up to 50-plus basis points lower. still ahead, the week ahead. the top of the agenda, payrolls report. that is next. this is bloomberg "real yield." ♪

♪ jonathan: i'm jonathan ferro. this is bloomberg "real yield." it is time for the final spread. over the next week, it begins this weekend, u.s. tariffs on $110 billion of chinese imports set to begin on sunday. monday, u.s. markets are closed for labor day.

tuesday, a decision from the rba. wednesday, we see pmi numbers from china. in the u.s., the beige book drops. this is the same day we hear from some fed voices. thursday, we get the u.s. adp employment change data along with jobless claims. this all leads up to the payroll report for the month of august on friday. back with us are james athey, greg staples, priya misra. to wrap things up, we have done almost the whole program without talking about trade and china. i wonder if we are focused too much on the tone and not the substance? the optics change every week. the tone shifts, but through the last 18 months, tariffs have stayed on, and more have gone on on top of that. priya: that is putting all of this uncertainty on the business sector around essentially supply chains. last friday, the tone went very negative. very dark. the fact that we didn't have a further darkening of that tone mattered for the broader macro market.

if you look at the structural issues between the u.s. and china, we have had the same issues for the last two years, ip, cyber. i'm not seeing any progress there. i also think politically, neither side has an incentive to reach a weak deal, so how do they sell this to their own population? i would argue there is no deal, and what that will do overtime is keep eroding business confidence. at what point do businesses say, maybe we should lower our pace of hiring, do we start paying people less? that is when it will spill over into the real economy. you make a good point. until you get resolution, that uncertainty is not coming off. gregory: it will be with us a while. i think the market is getting desensitized to trump tweets. to reading nuance in the chinese statements. it is the boy who cried wolf. you need to see some substance. there's a chance we will see something before the new tariffs go into effect, i could see

trump on saturday afternoon saying we are going to pass this on until december, like he did with the other half, but i think the u.s. has to come to the realization that tariffs are here to stay. james: not much new to add. i agree. the market is getting desensitized. the equity market probably less so. the equity market wants to see good news in every place it can. the bond market is a bit more cynical. realistically, priya is right. no movement on the true substance of these disagreements, so the rest of it is just noise and sentiment. jonathan: rushing us along. you know the drill, three questions, three quick answers. going into september, who cuts more in september, the ecb or the fed? james: the fed, unquestionably. priya: the fed. gregory: the fed. jonathan: do you stick with quality in credit or do you go down to the junky stuff? priya: stick with quality.

james: neither. you buy treasuries. gregory: stick with quality. jonathan: does anyone think the treasury will issue anything longer than a 30 year anytime soon? gregory: no. 2020, strong possibility. priya: it is a mistake but i think they'll probably do it. james: no, i think t back will say no. jonathan: james athey, great to have you with us, alongside greg staples, priya misra. that does it for us from new york city as we round out the month of i will see you in august. september. same time, same place. this was bloomberg "real yield." this is bloomberg tv. ♪ from the couldn't be prouders

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