jonathan: from new york city for our audience worldwide, i'm jonathan ferro. bloomberg "real yield" starts right now. ♪ 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 left facing down the european central bank courts. we begin with the big issue, a month to month for government debt. >> you have had a significant rally. >> big rally. >> huge rally in the bond market. >> huge inflows, one-sided trades. >> insatiable demand for yield. >> the message is that things

are slowing down. >> slowing down. >> growth is slowing everywhere. >> slowing global growth. >> the fed is not cutting fast enough to keep up with the falling growth outlook. >> they are actually behind the curve. >> likely to be 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. of aberdeen standard investments. in new york, greg staples, priya misra of td securities. priya, what a month it has been. the 10-year treasury, people forget, 2% feels like a lifetime ago. it was the end of july, where we started the month, and we are down near 1.50. priya: i think it means it is a monster 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 the fed put were shaken. we realized that sort of the last 300 billion of tariffs, a lot of people thought the president would not initiate tariffs on that because it has a disproportionate impact on the consumer. that happened first day of 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 to 0, they could offset all of this global growth uncertainty as well as the trade 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 big time. what they got was a drop of 50 basis points on 10's, and a similar move on 30's. is there anything at the moment in terms of what you see, that you can assign a higher probability to that will change that trend anytime soon?

james: high probability is difficult. what you are talking about is inflation shock or the fed gets very aggressive on monetary policy. the conversations we are hearing from regional fed 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 they like to be a consensus driven organization, we have heard that a number of times, seeing 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 and still like to own the front end, but i think it will take another hawkish mistake, shall we call it, in september for them to realize the pickle they got themselves into. jonathan: what is to like about the steepener right now? james: good question. in terms of the carry at the front end, it does not look great. in terms of the valuation, it does look good. it is very 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 a 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. we have gotten 50 basis points and have not seen anything happening. it has all been anticipatory. at this point, a lot of august was momentum. maybe it was algo driven at the end. we seem to be 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 have 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 ease in july, and now you are calling for them to ease again in september? you heard from rosengren and

esther george, we are not ready to do that. that could shock the markets. jonathan: what led to the steepening was secretary mnuchin coming out saying that he is still considering ultralong bond issuance. i would love your view on this. this is what the treasury borrowing advisory committee said in 2017. we have talked about this so many times. this was their advice back then. when ultralong is most likely to be demanded with those with longer dated liabilities. the committee does not see evidence of strong or sustainable demand beyond 30 years. of course, what matters is what the curve looks like now versus what it looks like in. -- look like then. but the advice, will it be any different this time around? priya: i would argue not. i think 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 ldi 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.

i think mnuchin, the president everybody wants a steeper curve. , we would all benefit, banks would benefit in a steeper curve. they can try to steepen how the -- steepen out the curve by issuing, but i don't know that it is the lowest cost to the taxpayer. the first issues they can do whatever how much more are they , going to keep issuing? is the demand going to be there at the second auction, third auction? how much can they do? they would have to issue a lot. i would argue the macro aspect is the data strong enough? , i think that will dominate. supply can be a knee-jerk steepening. i really do not see this captive demand that is waiting to buy these long end treasuries. jonathan: typically, we look at borrowing costs on the 30 year south of 2%, all time lows. why don't they go along, to 50, -- go long, to 50, to 100? what the treasury market has gotten so used to is the predictability of size, a certain maturity, every single quarter. is that worth 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 just lays down the foundation for shocks essentially. essentially, things cannot remain constant forever and a day. the idea of steepening for the sake of steepening i struggle with. if you go back far enough, the fed wanted to flatten the yield curve in order to stimulate the economy. what i care 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 bond rally. ism's in the u.s. have gone from 60 to 15. a straight unblemished line. we have seen headline payrolls grow slow, -500,000 jobs revision to the reports from march to march. from insurance, we have seen the working week and manufacturing declining precipitously. if you look outside of the u.s. borders, china is no longer the supplier, the demander that it

was, and that has brought the eurozone down. to me 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, then that is when it 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 have seen the data. we have seen some weakness in some areas like manufacturing, but look at retail sales this week. 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, it is too soon. they are hearing footsteps. rather than hearing something. jonathan: we have seen the bull flattening come through in august. big moves. what has also been interesting is what is happening in credit. very defensive, a flight to quality, investment-grade having a fantastic august. if you look at the high yield and the credit stack, bb's

outperforming ccc's. is that something we should get behind? priya: i think we should. it is different from the fourth quarter of last year. fourth quarter last year i read , that as a fed policy mistake. what we are seeing now is the first sign that maybe investors are worried about u.s. growth. if you look at the data front, 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? investors are saying, maybe we should look at that quality trade. they are buying treasuries, higher grade corporates, also buying the defensives 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.

we should be loading up on quality here. jonathan: james, is that an argument that resonates with you? do you agree with that? james: i agree with priya. what we have 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 in terminals of -- the internals of risk facing markets have been showing some time now a 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. there definitely is signal there. you also have to recognize the structure of the markets, the liquidity that has been thrown into them not just by the fed, but by global central banks. that money has to go somewhere. in a low yielding 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 early at this inflection point. internals rather than the

outlying spread is 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 drawing 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 year notes at a yield of 1.516%, 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. sticking in europe, italy selling 4 billion euros in 10-year notes this week, the average yield on the 2030 bond falling to an all-time low of 0.96%. let's stick with italy. weighing in on why 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 at 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: [laughter] how did i know you're going to come to me on that one? i struggle. i really do.

i understand and 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 italy has to deal with economically, socially, politically, and as a part of this monetary union which is starting to exhibit some of the stresses which concern me. the ecb is standing by, ever 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 is starting to look more interesting. if you go back a few months, you want to be short two-year btp's. it cost you 45 bps a year in role 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 got 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 1%, people say, what is going on? if you look at the tide. let's look at the spread of the italian 10-year versus the german ten-year all the way back to 2015. in the spring of 2015, 88 basis points. we are at 171 now. i know people think we can test those tights once again. do you believe that? gregory: it is all about politics. looks like we have a coalition between five-star and the pd. it will last for a little time. there will be a bit of a there will be a bit of a honeymoon, the rating agencies will bless the investment grade, but longer-term, salvini will try to break up the government. they have a difficult budget ahead of them in 2020. the e.u. will be looking to make sure they 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 closer to 1.30 on the bund. jonathan: you have to make a call on the government.

is it sustainable? is it a credit or a sovereign? that is what divides a lot of people. does it behave as a credit or sovereign security? which one is it? priya: right now, it behaves like a sovereign. the euro break-up risk is off the table. draghi in 2012 came in and said i'll do what it takes. i think you'll hear that again. we are 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 come in and start buying. even if they do not change the capital key, that spread widening, it is the widest spread. one more stat. for the japanese investor, fx hedge, italy is the only sovereign bond market that gives them anything more than jgb's. they will be back in 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? jonathan: i have lost count. priya: exactly. we have to live with that

political risk, but right now as we look for yield, as the ecb is coming in to do qe, we should be looking for that spread to compress. it should trade 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, two weeks time? priya: i think they will be heard, but i think the doves will outnumber them. if you look at what has happened from july until now since 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? there's a lot of research that maybe -75, -80 basis points may be the level which the ecb -- beyond which the ecb should not cut anymore. then it becomes counterproductive. so what do they do? they cut 20 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: base case for the ecb september 12? what is it for you, greg? gregory: i think they will ease. you know my feeling on this. i think their policy has been a disaster. i think negative interest rates, the hollowing out their banks, their insurance companies. they are making it difficult to fund pensions. they should stop doing that. but i think they are going to. that is draghi's last swan song. let's talk about -- what is their objective with quantitative easing? you have 10 year bunds at -70. 10 year italian bonds at plus ig 90. barely over 25. what are they trying to accomplish? what is the end game. jonathan: 25 basis points on euro denominated investment-grade debt, quite remarkable stuff. greg staples, priya misra, james athey staying with us.

coming up we will be talking about china and tariffs. the month, the week what a month , and week it has been. treasuries, not a massive move, down a basis point. on the 10 year to 1.52. on the 30 year down to it is the 1.99. moves on the month that matter. huge moves on 10's and 30's. up to 50 plus basis points lower. still ahead, the final spread, 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. coming up over the next week, it begins this weekend. u.s. tariffs on $110 billion of chinese imports set to begin on sunday. on 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 that we hear from the fed. thursday, we get the u.s. adp employment change and initial jobless claims. this all leads up to the payroll report for the month of august. 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 just wonder whether we are focused too much on the tone and not the substance? the optics change every week. the tone shifts. for the last 18 months, tariffs have gone on, 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 supply chain. 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. politically, neither side has an incentive to agree to a weak deal, so how do they sell this to their own population? what that will do over time 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. this trade thing, you make a good point. until you get resolution, that uncertainty is not coming off. greg: it will be with us for a while. i think the market is getting desensitized to trump tweets. it is the boy who cried wolf. you need to see some substance. there is a chance that we will see something before the new tariffs go into effect on sunday. 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 would not count on the. i think the u.s. has to come to the realization that tariffs are

here to stay, and to adjust accordingly. 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. there is no movement on the true substance of these disagreements, so the rest of it is just noise and sentiment. jonathan: i am doing my best to fit in the rapidfire around. you know the drill, three questions, three quick answers. going into september, who cuts more in september, the ecb or the fed? 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 the ladder 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: anytime soon, 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 jonathan: james athey, great to have you with us, alongside greg staples and priya misra. that does it for us, from new york city as we round out the month of august. i will see you in september. same time, same place. this was bloomberg "real yield." this is bloomberg tv. ♪

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