♪ jon: from new york city, i am jonathan ferro. this is "bloomberg real yield." ♪ jon: coming up, junk debt a shelter from the global equity market storm. the fed indicating it will not be enough to shape policy. the optimism supported by strong u.s. gdp. we begin with the riskiest part of fixed income, a basket of stability in a volatile world. >> credit conditions and lending standards remain extremely generous. >> what we have been saying a long time on credit is it is too

extensive to buy but too early to short. >> a basket of highly leveraged equities are underperforming. yet the fixed income credit markets are not that worried about it. it is a really interesting disconnect and quite unique. >> high yields should be compared to equities. certainly on a risk-adjusted basis, many on an absolute basis, high yields are looking more attractive. >> if you see lending standards tightened and credit spreads widening on a sustained basis, you know you will create a feedback loop into equities and head into recession. we don't think that is a story for the next few quarters yet. >> the u.s. recession looks a long way away to me. you would normally see credit starting to weaken and widen if we were starting to deteriorate in the underlying growth picture. that is not there at the moment. jon: joining me is rachel golder, marilyn watson, and robert tipp.

rachel, i want to begin with you. equity markets all over the place. junkihe junkie is to -- est part of junk is doing ok. leveraged loans are doing ok. why? rachel: you could feel equity is the beginning of the and and credit would catch down with it , or this is a flash in the pan and there will be a recovery with equity. we believe there will be a recovery. that the fundamentals of the economy are strong. you look at the underlying default rate, very benign and likely to be so for years to come. one of our strongest convictions is the energy recession of 2016-2016 really hit the reset button for corporate behavior for how the market was addressed , and gave the market a chance to heal. the quality of the market is not as dire as a lot of people have suggested.

jon: you're not alone in making that point that high-yield had its moment. do you share that view? marilyn: when you look at the high-yield market, there are strong technical reasons why it is doing well. the lack of supply versus demand, still strong demand for yields. you continue to see that. we are seeing a shift. you are starting to see better valuations in europe, for example. it is actually attractive now. i don't think it has had its day, but the fed continues to hike on the contingency. jon: robert? robert: it has been a sleeper outperformer this year. it is a good environment. the u.s. economy is doing well. while europe has been having problems, emerging markets were getting hit, investment-grade has more downside than upside and high-yield was the sweet spot. the equity market was racing away. in the u.s. uniquely, relative

to other countries, you have steep correction in equities spilling over a bit. to the extent that this recovery, this expansion, continues, they are likely to reemerge as a sweet spot. jon: it would be disingenuous of me to say credit has come out of this ok. we have seen spread widening in high-yield. the outperformance has been the worst part of high-yield. the broader point, leveraged loans have remained resilient. to your point, if there are people watching right now worried about the equity market volatility and downdraft, is the message that for credit, it is not that doom and gloom is not around the corner? i think leveraged is the hot area. that is the hot area where the value is not necessarily there. that is going to be the weak underbelly when we get to the next correction. in the meantime, technicals are strong there. it has gone from a wholesale cheap fixed income market in

credit from a couple of years ago, it is more of a bond pickers market. you have to be very selective , whether it is peripherals, high-yield, emerging markets. the most difficult to find, ig. why is the leveraged loan market technically strong? robert: retail demand is very high. you have a fed rate hike environment. that has created a bulletproof technical for that market despite high issuance. jon: rachel, are fundamentals strong? rachel: fundamentals are strong. the technical we need to mention is the clo demand. clo's now represent over 50% of the holder base. it is important to look at this as a relatively stable pool of assets. they will not be forced sellers in the next recession. they came through the financial crisis in good shape. they generated good returns.

so i see the clo base as a stabilizer, but also the demand from the clo's has created a demand that is relatively unique. the market has changed materially. the percentage of the market that is loan only has doubled in size in the last couple of years. you have weaker covenants and it has drifted down in ratings quality. i'm not saying we do not like loans. we like them in the view that rates are continuing up for the next couple of quarters. they will still be a go to investment asset class. jon: your point about them being loan only is important. there are a lot of people out there thinking they will be higher up in the capital structure. the problem is there will be nothing beneath them. what does this mean for recovery? a lot of people look at the historical analysis and say recovery rates are ok. is it a different market compared to 10 years ago? rachel: we expect it will be. you have entire structures composed of loans. there is no subordination or

first loss piece beneath the loans. if historically the low recovery rate has been $.70 on the dollar, we would use the lower number, probably $.60 or below that. it also depends on how stressed the balance sheets are. we would say overall leverage is not excessive. it is not terribly worrying. but then we would look at the nature of the underlying cash flow and say a lot of add backs have been permitted to boost that number. if you look at a more reliable cash flow number, these companies might be more leveraged. we think not only lower recoveries but also potentially more volatility. jon: this underlines how much homework you need to do right now. if you're piling into the space, how much homework do you need to be doing in leveraged loans at the moment? robert: exactly. those are the points. the demand is strong. clo demand is strong. you need a really robust credit team to go into every deal. if you have that, by the time we

get to the next downturn and you have been selective, you may have similar downside experience to high-yield. all things equal. for those going in that are not doing that homework, it is not going to be pretty. jon: in terms of return profile at the moment spreads for , high-yield have been wider. do you anticipate high-yield delivering a little performance relative to leveraged loans? or will it still be in leveraged loans for you? robert: i think it will still be in high-yield. that is for a couple of reasons. the high-yield spreads are down 50 basis points on the index and rates are up. i think we are getting to the point where a few interest rate hikes down the road, the fed will be done and there will be some dropping of the long-term yields. the cycle is probably not over. in which case, spreads are in. the technical point on the high-yield will be the superior convexity.

the loans get called away with the spreads tighten. they will not participate in the interest rate rally. jon: you don't think we have seen post crisis heights in the united states? robert: i don't. i think i.t. is different. there are opportunities. when you adjust for everything, the spreads were incredibly tight earlier in the yield. it seems unlikely we will go back there. in high-yield, if the fed succeeds and inoculating the economy and we have a moderation in growth for a few more years, i think the technicals could move the market quite a bit. jon: marilyn, do you share that view? marilyn: as we move forward in the fed continues to raise rates, i think one other aspect to be aware of is the change in andsize of the ig market, the triple b space especially, and how it has grown exponentially. as you get closer to recession or toward the end of the cycle, if you see downgrades from

triple b into high yields it is a factor you need to consider as well. jon: a final word on credit? rachel: i think there is a threshold that really matters to people. within the rate rise, we can see further spread compression. we would be buyers into the end of the year. technicals and fundamentals are looking good. jon: a bullish group today. rachel, alongside marilyn and robert. coming up, the auction block. netflix dangling high yields to investors in a $2 billion junk-bond offering. that is coming up next. this is "bloomberg real yield." ♪

♪ jon: i am jonathan ferro.

this is "bloomberg real yield." i want to head to the auction block, where netflix was the headliner for the week in high-yield. the company sold more than $2 billion. they had to offer yields at the high end of the price expectation. the first time that has happened for one of the company's debt sales. elsewhere, u.s. debt investors are helping to finance the future of the wheat industry. it sold more than $2 billion of bonds to boost its stake in the canadian wheat grower. spacex is said to be working with goldman sachs. they are raising $500 million of leveraged loans. spacex valuation has climbed to about $28 billion. this week, janet yellen joining people concerned about the rise of leveraged loans. she said in an interview, i am worried about the systemic risk associated with these loans. there has been a huge deterioration in standards. covenants have been loosened in leveraged lending. it is a big issue she has chimed

in on and many others have as well. still with me, rachel golder, marilyn watson, and robert tipp. robert, i raised that quote because i am wondering whether some current and former fed officials are trying to tell us something. the guiding light seems to be worries about financial assets and wobbles. robert: they are operating in a world of uncertainty. but they do know that what has ultimately has cost the average american, and even more than that, are the big downturns. the crashes, which are caused by the bubbles. those are the ones where the bulk of society recovers slowly. instead of being very cautious. it was probably five years ago she was warning on biotech, right? i think it behooves them to kick the tires and see if anything rattles. but i think that is what will extend the expansion, not seeing

the widespread access of aggressive lending versus appreciated assets, the real estate bubble, or any gigantic sector bubble, you are not seeing that but they continue to raise rates. i think in the end, that is what will be helpful. jon: that is the former fed chair. current fed officials, one of them warned this week about the leveraged loan market in a sort of emphatic way. chairman jay powell has talked about financial instabilities being the biggest risk. not so much inflation. marilyn i'm trying to get my , head around this. on a week where fed officials have come out one after one and said the equity market volatility will not force them to pull back on the rate cap, -- rate path, i'm wondering what the guiding light is for them now. marliyn: that is the $1 million question. they made it clear they are not sure where the neutral rate is. the economy continues to do incredibly well.

we are seeing strong data from consumption data. but we are starting to see, though, the impact in the housing market and other rate sensitive sectors like the auto sectors. so we are starting to see where rate rises are having more of an impact now. i think, especially as we get into next year, the committee has less of the consensus around two or three or four hikes next year. the question becomes, at what e and do they cause -- paus start to go on a meeting by meeting basis rather than consistent, gradual increase in rates? jon: we are seeing tensions emerge between the market pricing, and where the fed is telling us the hikes will be. even this week, a slightly pricing and where december will be, whether the hike comes through are not. i am wondering where the market is and where the federal reserve is and how the spread reconciles in next 12 months. rachel: the fed and the market

have gotten much more closely aligned in the last couple of months than they had been in the past. now it looks as though powell is trying to dial down the reliance on the forward guidance, trying to paint a steady picture going forward. we still think the fed put is there but it is deeply out of the money and you are seeing the strong economy with decent inflation but not an immediate threat of inflation breaking out to the upside. as we go into 2019, there are a number of other forces that will begin to push the fed's hand. we think the tax reform has been a tailwind for 12 months. that will begin to fade. trade is already beginning to cause supply-chain disruptions. as we look at the difference between the performance of the equity market, which is been very weak, and the credit

market, which is been somewhat stronger, i think it relates to the expectation of slowing topline growth. you have slowing topline growth. if margins begin to erode, you will see leverage worsening. this is just one of the piece of the puzzle of tighter financial conditions, and that will influence the fed's hand. it is just not immediate. jon: you mentioned inflation. i think that is important. inflation expectations, are they starting to roll over a little bit? just looking at the five-year maturity, you start to see some signs of that happening. robert: today, you are seeing it. it is surprising how little they have come down given how much energy has come off. the curve is incredibly flat, which suggests the market is not -- market does not have a strong view about where it will be headed long-term. on the said, when you look out a your code -- out a year or two in the fiscal is fading, and presumably energy prices will crash and go horizontally, when they are at a neutral rate and the economy is doing well and there are not clear inflation

pressures building, i think the onus will rise for them because they will be going into possibly restrictive territory and hurting the economy when they are not sure they need to do it. jon: is it hurting the economy right now? robert: i don't think so. i think they have safely created room to cut so far. the economy has plowed through this. you are beginning to see in new home sales, in particular, a correction which has extended further. there have been waves in the rise the last handful of years. this one is beginning to be longer than the ones before. the interest rate sensitive sectors are beginning to bite. they are thinking they have two or three more moves before they need to slow down. maybe they need to slow down sooner. jon: you are going to stick with me. in the markets this week, a check on where treasuries have been. twos, tens, and treasury yields 30's. shaping up as follows.

treasuries receding a bit on the front end. down by 10 on a 10-year. down to 332 on a 30 year. still ahead, the final spread and the week ahead featuring two major central bank decisions and payrolls report around the corner. from new york, this is "bloomberg real yield." ♪

♪ jon: i'm jonathan ferro. this is "bloomberg real yield." time for the final spread. over the next week, we will have a pair of central bank rate decisions. one from the bank of england other from the bank of japan. we will get another round of earnings. the brazilian election and the u.s. jobs report to close out the week next friday. payroll friday around the corner. marilyn, rachel, and robert are still with me. speaking of blackrock, the front end has been a story, the

repricing on treasuries. are we getting to the point where we could be close to the peak? marliyn: we still like the front end of the curve. it might be from here well anchored. if you continue to hold that, we think it is reasonably priced in now the number of hikes you , might have. the next move could be more of a steepening if the fed does indicate it will pull its rate hiking cycle. even if yields go up more, you are still cushioned. further up the curve, there is no cushion. jon: walk us through why the next move could be a steep one. and what the catalyst will be for it. marliyn: if the fed announces it will pull, the market is not prepared for that. we have seen some movement and a few signs the market is

concerned, but it is not yet priced in the fed might act sooner rather than later. willa -- that potentially raise rates in december but i think next year, the market will start to reassess its view of the rate hiking cycle. it will reassess its view of the u.s. relative to europe and japan. you have seen the curve flattening most of the year. now we are seeing it steepen a little bit. it has been supported by pension investors, foreign investors. i think some of it has played through. also the fx hedging cost is so expensive, now you can see foreign investors going elsewhere and getting better yields. jon: it has been a big conviction trade for you. have you changed your view? robert: i think it has relocated a bit. the bond was a spectacular performer. part of that was the shift in issuance. the fear with trump coming in

was they might extend and want to do ultralong treasuries. instead, last year, they moved supply heavily to the front end curve. of the treasury curve. they have been pounding that and introducing new maturities on the front into the curve. bond has been a spectacular performer until lately. i think now the performance spot is between fives and 10's. at this point, it may be too early for 2's. if you look at the last rate hike cycle, they peaked with the last hike. if the last hike is going to be close to or above 3%, 2's may have some downside. at that point, you will probably be inverted. jon: we have to wrap it up with the rapid fire round. quick final questions with quick answers, if you can. will credit still lead equity going into the next downturn? yes or no? rachel: yes. marliyn: yes. robert: yes.

jon: have we seen the post crisis hike on high-yield? rachel: yes. marliyn: no. robert: i don't know. jon: is the fed put a thing of the past? >> no. >> yes. >> no. jon: interesting stuff. thank you for joining me over the last 30 minutes. my special thanks to marilyn, rachel, and robert. that is it for us this week. we will be back in new york same time, same place. friday, 1:00 in new york. this was "bloomberg real yield"" this is bloomberg tv. ♪

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