jonathan: from new york city for our viewers worldwide, i'm jonathan ferro bloomberg "real yield" starts right now. ♪ coming up, a fractured fed delivers another rate cut as trade ties between the u.s. and china resume. optimism driving junk-bond toward a fifth straight week of gains. yield hit 20-month lows. the new york fed rolling out an old tool, funding markets signing some stability. we begin with the big issue. a fractured fed meets a wall of skepticism. >> a lot of dissension in the ranks. >> there is a little bit of a split in the dots.

>> there are honest differences of opinion and how vulnerable the u.s. economy is. >> on one hand, certain parts of growth, especially domestically, that are holding up. >> you can make the argument that the fed should not do anything. >> on the other hand, you have trade war, geopolitical risks. >> manufacturing is slowing down. >> capex spending is going down. >> you will find more and more divisions in the committee. >> they want to see more cuts by the fed. jonathan: joining me here in new york city, priya misra, diana amoa, and krishna memani. let's begin with you, priya, your thoughts on the potential of another rate cut before year's end? priya: we are looking for another rate cut in october. the fed is putting in some insurance cuts. our view is the consumer will show signs of stress, so we see the fed cutting three more times next year.

i did not read the fed as being that hawkish. i think relative to where they were in july come in july, chair powell said midcycle adjustment. we are cutting down but we may take it back. i think that was a communication mistake. he is facing a divided committee. what i heard this week is we don't know, we are still in the process of running this midcycle adjustment -- and noticed he didn't use the word midcycle adjustment. but he has gotten more of the committee into this insurance camp. i am looking at the seven dots that has one more cut penciled in. i think the fed is trying to retain optionality. i think chair powell and vice chair clarida today said meeting by meeting, but one more cut as part of this midcycle adjustment insurance preemptive risk management, these are all the terms to be saying, the data is not bad but the downside risks are high enough. i think they are trying to be noncommittal rather than hawkish. jonathan: i think the chairman did a really good communication

effort, when it is difficult to find a central view of a divided fed. the problem, diana, is that can communication effort was hijacked by the dot plot. how much should you read into the dispersion among policymakers? diana: first of all, the dot plots are an assessment of where the policymakers think the policy should be given the economic framework. it is not a projection of the direction of rates. the chairman did a good job of giving himself enough wiggle room, so if things deteriorate, they will be able to act. this over focus on the dots removes the fact that he has opened up the door, similar to what mario draghi did. if things deteriorate, we will be ready to act. we expect more slowdowns to come through from china and the rest of the world. this is clearly a fed that is central bank to the world, and that will impact financial conditions outside. they will be forced to cut once,

maybe twice again this year. jonathan: the other problem is that every dot is a policy maker, some of them have a vote, and others are more important than others. krishna: the one thing i have learned about the dot plots over the last two years is to ignore them. they don't tell you anything. we have done things where the dot plots have said one thing and done something totally different later on. i think the dot plot is something that has to be put in the dustbin of history. it was valuable at one point. it is absolutely meaningless today. having said that, what the dot plot is telling you is there is dissension. when the fed tighten policy in 2018, almost a mistake. now they are unwinding. that dissension is to be expected. at least it is not as bad as the ecb, where you don't even need to take a vote. dissension is to be expected,

but there is enough of a majority within the committee for us to have a few more rate cuts for this cycle -- easing cycle is over. jonathan: several transmission mechanisms to reach the real economy, one is comedic asian. -- munication. putting on your communication communication. putting on your communication and reaching the end consumer, market or discipline, whoever. i just wonder whether the dissent is complicating that effort. to what degree is that true? krishna: it certainly is true, but powell did a masterful job in the press conference. the midcycle adjustment was all about highlighting that dissension. dodging the issue altogether, keeping the fed's optionality shows the maturation that he is going through. fantastic. we need a fed like that, rather than putting everything out on the table. things are uncertain. having that flexibility is

important. jonathan: there is an argument that 25 was not enough, they should have gone harder. they should have been emphasizing through the future that more rate cuts are coming. when you look at the yield curve, 2/10, it flattened. what is the argument that they are not doing enough quickly enough, or is it just people questioning monetary policy? every rate cut they deliver, you push that through the curve and dragged the whole curve lower. priya: i think it is the latter. we realize this is not an interest rate problem. chair powell said that in the july press conference, which i struggled with. you have the fed chair saying this is not an interest rate problem, so how my solving this? by cutting interest rates. even if they had gone 50, the car would have flattened. they are a little bit stuck here. all they can say is clarified the reaction function. if the economy weakens more, we are ready to do more, ready to do what it takes, ready to go to zero as it purchases.

-- asset purchases. part of the curve flattening was also nervousness around the repo market. they expected a permanent fix from the fed. it is hard for them within two days for the fed to come out and say we are about to make massive change. there was disappointment there. the fact that breakevens are declining, i would not just look at this week, look at since the first rate cut, inflation expectations have declined. is the market telling the fed that interest rate cuts will not solve this problem? jonathan: we will spend some time focusing on the repo is sue. diana, focus on the rates market. this week, pretty much every day, yields grinding a little bit lower. is there an argument to make, keep nibbling away on that backup whenever you get one. diana: that is the argument. this is an attractive entry-level for people who want

to add duration. ultimately, the gravity from the rest of the world on the back end is too high. you have negative yielding debt elsewhere in the world, and this view is entrenched. in europe, the focus to turn rates negative is not until five years down the road. additionally, from the fed point of view -- and i agree with you about inflation being a concern for them -- their statement of economic projections has core pce heading to 2% in 2021. as a policy maker, i'm sure they are very concerned about that. it would put a lot more weight toward, if they cannot change this narrative to re-steepen the curve, maybe qe at some point, to get more animal spirits, then the weight of gravity for rates and from our point of view, is lower. krishna: there is an argument to be made for rates to go lower, but that would be the wrong

argument. at the end of the day, the driver of that really is going to be the state of the economy, the state of the u.s. economy, far more than europe. the rally so far had been driven by the fact that the u.s. growth was moderating and pressures overseas were significant. data stabilized. data may strengthen in the back half. if not in the back half, and maybe if we reach a trade deal, then 2020, for sure. 2% is much more likely for 10-year, than 1.5%. jonathan: to what extent does that hinge on a trade deal? the president saying he is looking for a complete deal, not a partial deal. krishna: actually he is not. the underlining day -- data is improving and stabilizing. if that continues to be the trend for 6, 12 months, i think

rates are going higher rather than lower. jonathan: is it improving or improving just relative to expectations? if you take my bloomberg, it is a complicated screen, but a quick snapshot of where we are relative to expectations. if you compare this to where we were couple of months ago, completely different. even just a couple of months ago. a lot of that was pointing down negatively. krishna, is it about a positive upside surprise or an inflection in the trend of the data that we see the improvement? krishna: data is not strengthening. it is basically stabilizing and improving relative to expectations that are built into the market. if we are going to have to -- two percent sustainable growth, i cannot have an argument as to why ten-year rates have to be at 1%.

i don't care where they are in europe because we are domestic economies. from that standpoint, the change in actual results relative to expectation, that is the driver for the backup we have seen so far. priya: i completely agree with krishna here, it's about the u.s. economy. where i disagree, if the economy is strong right now, is it because of residual momentum from the fiscal stimulus? the fact that global growth continues to fall, oecd lowered they loweredhat their growth forecast for next year. at some point, the business sector that is already cutting, do they start expecting higher? if growth does not moderate, 110's can go up -- 10's can go up to 2%. jonathan: everyone around the table is sticking with me. coming up on the program, the

auction block. u.s. junk bonds heading for a fifth straight weekly gain. that conversation is coming up next. this is bloomberg "real yield." ♪

jonathan: i'm jonathan ferro . this is bloomberg "real yield." we want to go to the auction block in europe where weekly sales are breaking 50 billion euros for only the fourth time in 2019. here in the u.s., the high-grade corporate market posting $20 billion in sales. issuance in junk that slowed -- debt slowed after the busiest week in more than two years. elsewhere, the majority of loans being probably well-received. sticking with a high-yield credit market, some strong words, seeing many signs of froth.

>> the most recent sign in addition to the pickup in issuance, but when you see deals, that sort of starts to make the hair on the back of my neck stand up a touch. we also see things like the spread between double bees or bees and double sees widening. one of the reason you see that late cycle as credit deteriorates, the weaker companies suffer weaker credit deterioration before some of the higher rated companies. jonathan: around the table with me is priya misra, diana amoa, and krishna memani. spread some come in, we are at the tightest, almost for the year. 20-month lows of he and yields. your thoughts and where we are at the moment? krishna: the argument for high-yield being expensive is very easy to make. yield levels are low, spread levels are tight.

high-yield is not cheap by any measure. however, for income, there are very few choices that most investors have. if you look at the flows, they are speaking with their dollars, putting money into investment grade market, fixed income, rather than equities, because they think it is better value. the key point with respect to valuations is, you use valuations to arrive at how much risk you want to take, rather than what risk you want to take. if you look at history, if you went by valuations to make judgments about any market, that has gone to a wrong answer far more than the right answer. priya: i would say this is an environment of hedging. i'm concerned about the economy. i don't know if i would be in high-yield. i am not a credit analyst, but this would be a time to do active management. also liquidity. i will keep highlighting that i

think credit market liquidity is not what it was many years ago. i would argue owning treasuries as a hedge. that will give you protection against any weakness in the economic data, or any liquidity event. jonathan: your choice set is always as follows to get that income, take more ration risk, or sacrifice liquidity. what is the precedent for you, diana? diana: given what we have seen in various pockets of the market, liquidity has to be a big consideration. we are of the similar view that we are in the late cycle of the economic expansion. with that in mind, you don't want to be piling into high-heeled. our strategy is up in quality, going into quality government duration, rather than buying high-yield. jonathan: where does e.m. fall into the calculus? diana: on the one hand, you have governments cutting rates, but you have to be selective. you have better quality names

where policy is supportive, which would support some local markets. we have seen a strong duration rally in yield local. central banks have been cutting. within sovereign space, credit, there is value in going up. those spreads are similar to what you see elsewhere, but there is still value to be had going up the credit spectrum, because of that income bid. jonathan: the long dated credit has had a massive year through 2019. there is an index here at bloomberg which captures the long dated names within corporate credit, and gains north of 20% in 2019. is there any incentive to go further out along the curve for these corporate names? is it steep enough to have that incentive, i will take the longer dated corporate paper? krishna: i don't think so. if people are buying long bonds, it is for the hedging purposes, rather than for the purpose that it represents tremendous value.

a diversified portfolio, where you can own a lot of things, if i wanted long-duration exposure, i would probably buy treasuries rather than corporate bonds because the risk is significant higher. having said that, e.m. is an interesting space at the moment. if e.m., if you buy e.m., you have to have a view on which way the trade stuff is blowing. that can have a meaningful impact on currencies. that can take away all the returns. we have a positive view, we don't think things get exacerbated a lot, therefore, e.m. real rates represent one of the better values in fixed income. priya: i would say parts of e.m. can make sense, but if the dollar remains strong, that is our biggest fear. if the u.s. is still outperforming on a global growth

standpoint, the dollar will continue to strengthen. that will be a headwind for e.m. owning some e.m. and ten-year treasuries. i think it is a good hedge even against e.m. you are getting yield but you need something to hedge. jonathan: diana, it is your world, e.m. i will give you the final world. diana: i like owning em risk, and owning some duration against it. if you have that trade on, you have been making a killing on both sides. if we don't get a resolution on trade, that government duration will protect you. jonathan: coming up, the week ahead featuring a slew of economic data, and another big week of feta speak. that is next. -- fed speak. this is bloomberg "real yield." ♪

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

on monday, we get u.s. and eurozone emi for the month of -- pmi's for the month of september. fed members speaking throughout the week. tuesday, u.s. consumer confidence numbers and german data. finally on friday, u.s. personal income and spending numbers. with me around the table still is priya misra, diana amoa, and krishna memani. you have been talking about this for 12 months. the issues that we see this week in the repo market, and you are not putting it down to corporate pulling money from market money funds, you have been talking about this for a while. it comes down to reserves. walk me through the dynamic. why is it so important? it is a problem that needs addressing now. priya: it's a question of reserve scarcity. it is really the distribution of reserves. until number of excess reserves in the system is about 1.3 trillion. the fed has been saying perhaps

900 billion to one trillion is enough. therefore we are in an excess reserve regime, and reserves have been falling for quite some time. most of it was because the fed was leading the portfolio runoff. even if they stop that, it will continue to fall because currency circulation continues to grow. because of the regulatory environment, which has changed in the last five years, even though the total amount of reserves are ok, the interbank trading is not happening. there is a massive difference between the haves and have-nots when it comes to bank reserves. i would argue that any time you get any small dislocation around supply demand for reserves, you will get these outside spikes in repo. we saw this at year-end, in april around the tax date. we are seeing it again. i think the fed has reacted much faster than people expected. i am very pleased that they have addressed the quarter and issue already.

every day my blood pressure would rise between 2:00 and 4:00 because we would see if the fed would do another overnight operation. they have said they would be doing these, they are doing a term operation. i really hope they address the structural issue, which we think they will. in october, we think they will come in and start buying assets. it is like huey, but it is what they need to do to prevent reserves from declining. that means the market will come in and buy treasuries. jonathan: t-bills or throughout the whole curve? priya: they are buying across the curve are now, so why money the waters? make that $45 billion a month. they have to clarify this is not because of the economy but they don't want financial conditions to tighten. jonathan: you have done a fantastic job flagging this over the last year. if anyone wants to reach out to priya on the subject, i encourage you to.

i want to wrap this program up the way we always do with the rapidfire round. through to year end, you have to hold one asset class. u.s. high-yield or e.m.? krishna: e.m. diana: e.m. priya: neither, but if i had to, e.m. jonathan: one markup this year by the fed or are they done? diana: one more, possibly two. krishna: two. priya: one or two. jonathan: is the repo rate a problem of last week or months to come? pre-a: months to come. >> months to come. krishna: last week. jonathan: great to catch up with all of you. that does it for all of us in new york city. this was bloomberg "real yield." this is bloomberg tv. devices are like doorways

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