jonathan: from new york city, i am jonathan ferro with 30 minutes dedicated to fixed income. this is "bloomberg real yield." ♪ jonathan: the president signs the tax bill and the treasury curve steepens. risk assets outperform a 2017. junk bonds get left behind. in europe, we end the year just the way we started it, worrying about politics. we begin with the big issue, the yield curve beginning to steepen. >> the reality is, this curve should steepen because there will be less foreign participation for treasuries. when you add in the $700 billion

of incremental issuance next year, we think that the recipe for a steeper curve. >> is unlikely the curve ends next year steeper than it is currently? highly unlikely unless the fed puts the rate hikes on ice or starts to ease. very unlikely scenario. >> very much likely contining to flatten. in that environment we of the paint strong growth, inflation maybe ticks up a little bit. it doesn't get out of control. the yield curve continues to flatten. critically, it does not invert. >> i'm worried about it, too. i think we need to watch it. the 10-year treasury, high 230's is meaningful. here is why. the history of inversions is such that it is tending to be a reliable forward indicator of recession. >> whatever you think about the way the world is supposed to work, it does not work that way in the last two weeks of the year. yes, yields have been going up. i think it's a function of very

strong equity markets. if they were to correct, they would go back down. i want to see them stay there after the first of the year. jonathan: joining me in new york city is greg peters, george goncalves plus, matt toms. thank you very much for giving us your time. i know you were trying to run off and get away for the holidays. let's begin with the statement we have seen throughout the week. monday, tuesday, wednesday was looking aggressive. technical, just some year-end windowdressing? or are we waking up some tax cuts? >> the market realized that the president passed the tax bill in the law. i think it will be more supply next year. they had this prevailing fundamental view, but now we will have more supply and the fed is still unwinding the balance sheet. greg: i think it is a little overdone. the flatten there was a little overdone. this is a recalibrating.

i think that these thesis holds. i think the flatten or works into 2018. jonathan: are you worried about it? i can't figure many people think it will go the other way. greg: i see the consensus flipping around depending on how the curve moves. jonathan: price sets narrative? greg: people are genuinely worried about supply. you are having potential he a lot of bonds hit the market and that could change the price. jonathan: matt? matt: agreed. ultimately the dollar weakness has allowed this flatness. it is important date 10% decline in the dollar has allowed the fed to push expectations of two , two and a quarter. that flattened the curve. growth could push the backend next year. that would be the change. jonathan: just to bring the does dollarics

dynamics into next year, i was looking at the forecast for g-10 and could not believe how you did the forecasted price action is for euro-dollar. some people think it will be a nothing year for g-10. do you share that view? matt: it was certainly nothing year in 2017. it was voll is dead, long live voll. it is unlikely to be that muted. you have central banks in diametrically opposed positions. the fed is looking to constrain monetary policy and the ecb and japan are heading in the opposite direction. something is likely to break. we don't think those forecast will hold. we would be biased towards a stronger dollar. jonathan: let's talk about what is going to break. this spread between treasuries and bonds is getting wider and wider. we are pushing to 260 on the front end just the other week. what is going to happen here? where are we going here? greg: both are critical.

the front end of the bund curve is way too low. short to front end i think it works in 2018 finally. at the same time, in the u.s. i don't think enough is priced in. both have to move almost in concert. that said, i think it continues to widen. not narrow. jonathan: looking across the curve, -62 basis points. going to a just toward the depot rate at the ecb or start thinking about rate hikes? what will happen to the front end of bunds? greg: you slowly moved towards the depot rate. at some point you will see a move towards the depot rate, not anytime soon, put you need to see the normalization. that will take time. george: the global rates have been supporting all fixed income markets. it is critical to see what happens in europe. people complain about bond

bubbles, that has been artificially engineered by the ecb in europe's case. you have to see european rates release for u.s. rates to go higher. jonathan: i feel like are so many years, we sat here and said, this does not make sense. yields don't make sense. look at the data, the unemployment, growth. i can't see why you have -70 on a one-year german bund. why you are at 30 basis points, 40 basis points on a 10-year. could we say that for a few more years? greg: it's important to decompose the front end in the backend. the bund market is driven by the ecb. the backend in europe and the u.s. is driven by inflation dynamics and growth dynamics. the truth of the matter is those are not necessarily overly robust. you layer on top of it a tremendous need for duration and yield. there is a starving yield market. you really need to see something meaningfully change.

jonathan: you had a great year not only saving all that reflation talk, you think that will be the story next year? greg: i do. the same story but with more volatility. i think the issuance in the market is going to drive more voll, but it think the general trend is still in place. the demographic trend is really tough to shake. therein lies the fundamental issue that the economy faces. jonathan: matt, inflation risk. there was an auction this week with a strong did come into it. some people referring to that is just a call option on inflation next year. is it a hedge or something a little bit more, people having more conviction about what may happen going into 2018? matt: we think it's a good time to buy a call option. you have countervailing forces. the overall inflation print has

shown 1.5 is still muted. we think there are two dynamics. there is an unwind of a global disinflationary trade that is slowly going to stop the present inflationary levels. the demographic trends mentioned will continue to have that build. it will not skyrocket, but as the global suppression unwinds , we think you will see a build in inflationary pressure. not a bad time to look for the call option to the upside. that could bring volatility next year that is not forecasted currently. jonathan: is now the time to buy the call option? or is that just a waste of money? greg: we will see if the phillips curve is dead or not in 2018. it is not a terrible call option to have, but the inflation pressures are not as pronounced as some people believe. it is really about this year. george: we think the phillips curve is very flat. the further we get the unemployment rate down, you will see that kick in the wages. beyond that, greg is right, the

structural forces are going to be there and keep inflation in check. you can still have a cyclical move. i think matt is right on the other side. at least at some point in 2018 inflation will move higher. having the call option makes a lot of sense. jonathan: can unemployment test the low threes? george: we think there will be a move towards 3.5%. there is potential for that. we will see how all the fiscal stimulus gets through and have it result in more jobs. the scope of the economy continues to grow. jonathan: gents are sticking with me. coming up, the auction block. the u.s. tax bill causes a u-turn in the market. this is "bloomberg real yield." ♪

♪ jonathan: from new york, this is "bloomberg real yield." it is time to head to the auction block. it was a record year for global investment-grade issuance. it topped $2.2 trillion with more than 8300 debt sales. banks forecasting lower issuance next year. as limits on interest to deductibility and we at creation could affect borrowing. meanwhile, in u.s. moneys, the sector sold a record $55.6 billion in december, breaking a record that stood for 32 years. in 2018, the u.s. is about to sell the most the debt in eight years. to discuss supply and the demand for it, greg peters, george goncalves, matt toms. greg, let's talk about credit and treasuries. let's have a discussion about credit and the supply we could see. we've had record years after record year.

next year, is it going to be different with the tax plan? greg: each and every year it is forecasted for lower supply, and it never happens. we are breaking record after record. maybe we won't have the same type of levels, but it will be quite elevated. corporate america is still very much focused on debt and that is not going to change. anytime soon jonathan: matt? matt: completely agreed. there is a trend towards funding in the dollar market in the european market. if there is a vulnerability it is a increasing reliance on dollar funding in euro. we don't see a force that has a unwind in 2018. can youn: george, ki talk about distinction. the amount of supply we have seen this year and draw the station between the issuance that is come through for refinancing and the issuance just a push up the debt? george: if there is any year that could see reduction, next year is the year.

it has always been hard to call these tops. there is a taxable implications. there has been some pulling for ward in financing. the fed has been the most televised fed in history. jonathan: they finally did with they told us they would do. george: it was well televised and corporate borrowers took advantage for the last 18 to 24 months. we should see a little bit of a pullback. jonathan: there was some worrying turn in growth issuance? or is it net issuance climbing because of refinancing? matt: it is a little bit of growth. growth is higher but net is also higher as well. they are refinancing, but also adding to this stockpile of debt. jonathan: let's talk about the demand side. will there be the appetite in the same way there was this year? i looked at high-yield and i can compare high-yield to other risk assets this year. take the s&p 500, em, compare to the performance of junk debt. junk debt has done nothing all year.

why? greg: supply dynamics are different. the buyer base is different as well. what helped the investment-grade corporate bond market has been the foreign participation. foreign investors have been forced out of their jurisdictions into the u.s. market. they either buy duration or credit, but they don't get on a high yield. it is more of a captive audience. as a consequence it has not performed the same way. you had some idiosyncratic issues pop up like toys "r" us and others. i think it has kept the markets on edge. jonathan: walk me through what -- through why we have not had a performance against the backdrop a strong performance in risk assets. why high-yield is completely lagged. matt: it's important to note it lagged within a very low volatility range. 5.5% to 6% yield range over the year. high-yield has marched sideways and you have clipped a decent

coupon. it is the bubbling up of demand for other asset classes that has propelled them as far or further than they should have gone. it is hard to look at high-yield as a failure. it is more looking at global flows that push other things further, including ig, which is near 94 basis points in a low range this year, and equities. it's important to note is not a specific weakness. and the internals for high year -- high-yield are quite strong. jonathan: is 2018 the year for coupon clipping or do you get capital returns as well? matt: it is hard to forecast a lot of capital returns and the fixed income market. it is a year for coupon clipping and looking to avoid downside risks. this is a year, we believe you are meant to sell the rallies, not buy the dips and avoid downside risk. george: totally agree. returns will be about half of this year in fixed income. much wider distribution. what punctuated this year was

such a narrow distribution of outcomes that the base case was easy. now you have a base case but you have upside and downside around it. it's a much more treacherous year in 2018 than it has been this year. jonathan: you agree? george: i think so. differentiation steps and as the fed keeps raising rates. we think ig benefited. that will go away. each time funding costs go higher, the fed is lifting rates to make ig more attractive. jonathan: why with the flow stories not be beneficial next year? ecb will still be in the market. why is that flow story still not positive in the united states? george: literally your costs of getting into the trades are more expensive. when rates were at zero, both japanese and european investors were agnostic. they would stay local or global. now that will probably say local. greg: the cross-country currency

basis is the real equalizer. they can't meet deferral rate. that just says the opportunities are much less. i don't think you'll see the same kind of flow and i don't think you will see the same kind of talent. jonathan: because of that, is that why you might see more u.s. money going to europe, when on an absolute basis it might outlook attractive, but once you a quite, it looks like nothing else? greg: the problem is it's a very volatile estimate. the cross currency basis, you don't buy a credit because of cross currency basis. that is a bad way to think about it. you need to disconnect those two. >> do you agree with that george: absolutely. jonathan: i want to give you a market check as we approach the close of the year not too far away. the big story, up 15 on a 30

year no. this story is curve steepening, not flattening. still ahead, the final spread. the week ahead features a glimpse of potential political trouble in europe. this is "bloomberg real yield." ♪

♪ jonathan: i am jonathan ferro. this is "bloomberg real yield." it is time for final spread. coming up in the next week, u.s. and european markets closed for christmas. a light week of events. boj minutes, u.s. economic data, and the italian prime minister is expected to hold a news conference marking the end of his administration and the start of the countdown to spring elections. still with me, george concalves, greg peters, and matt toms. matt, i feel like we have spent the year worrying about european politics and it has yielded very little for our efforts. why should be worried about

politics now, if at all? matt: ultimately you need to look to the change of the ecb leadership at the end of 2018 and into 2019. the political framework in europe will guide how much leash the ecb gets. that will be a story in the second half of 2018. if you infuse volatility ahead of that, that could create turbulence in markets. that is not being talked about but it will come center stage in the second half of 2018. jonathan: i asked the question because if you take the catalonian regional debt and look at the performance of the bond, if you faded the panic, there was a massive opportunity to buy the bottom in september-october. that for me captures the whole story of the year in europe. don't worry about the politics. why is it going to change? greg: politics have been basically white noise this year. you have been paid to focus on the fundamentals and was

happening on the fiscal side. i still think that's the trend. i think politics, unless you see something fundamentally shift and the rise of populism everyone was worried about this year has subsided. i still think you are better off focusing on fundamentals. george: after the french election it went flat in europe. zero voll and european government bonds. that speaks to it. all of these side jobs and noise. jonathan: i think for many people outside of the euro performance, they found it difficult after the french election to find a way to capture the positive story in europe. yields just won't go high. can't get into equities. you you can't squeeze much out of that at the back end of the year. one place you have is cocoas, bank debt. you can see the performance the 2017. we have absolutely ripped. is there anything left to squeeze out of one of the big trades in europe this year? greg: i like european financials, but cocos, there is

a misunderstanding of the co-option. i think a lot of investors are in that space and they really don't know what they are investing in. jonathan: what you thinking? greg: you're better off more senior in capital structure because these things can get tized.te ties -- equi it is hard to price the option. it's nothing more than a data trade. that works when it works, but when there is an idiosyncratic issue, they get completely wiped out. banco popular is a good example. you lost basically 90% in a day. that is a structural issue i think people underestimated. jonathan: matt, do you agree with that? do you take the cocoas? matt: i would agree with greg. this is not to be taking longtailed risk. the reward is just not there. that is true across the vix and income spectrum. it is time to upgrade a portfolio overall and not take longtailed risks.

you not compensated. jonathan: is that the thing next year? de-risk a little bit? greg: i think so. it's about taking chips off the table. you just had massive tax cuts in the u.s. a mere talking about de-risking. greg: what are you getting from it? a ballooning deficit is not a great risk reward from investor standpoint. i think many investors believe it is ephemeral and a very big cost. i think you're getting paid to de-risk. risk premium is piked. jonathan: we will wrap things up and look at 2018. one word answers if you can. 10-year u.s. treasury's? higher or lower by the end of 2018? greg: lower. george: higher. matt: higher. jonathan: bund treasury spread

wider or narrower? ,>> wider. >> wider. >> narrower. jonathan: he have to hold this from now until year end next year. tesla 2025, or the austrian century bond? they are all personal, obviously. you get the tesla 2025 when the austrian century? greg: austrian century. george: long-duration, austrian century. matt: i will do the same. austrian century. jonathan: some consensus on an austrian century bond. it has been great. thank you george concalves, greg peters, and matt toms. that does it for us. i will see you next year. this is "bloomberg real yield." ♪

♪ yousef: welcome to the best of "bloomberg markets: middle east". i am yousef gamal el-din. kicking off with the saudi arabia story, the country unveiled a new spending plan to revive its plunging economy. we hear from the country's finance and economy minister. saudi arabia's energy minister says global stockpiles will not be anywhere near close to the targets by opec. he says he is waiting for the second half of