jonathan: from new york city for our viewers worldwide, i am jonathan ferro with 30 minutes dedicated to fixed income. this is "bloomberg real yield." ♪ jonathan: coming up, the junkiest junk debt a shelter from the global equity market storm. the fed indicating a market correction will not be enough to shape policy. and the optimism supported by strong u.s. gdp -- a better than expected 3.5%. we begin with the big issue, the riskiest part of fixed income, a bastion of stability in a volatile world. >> credit conditions and lending standards remain extremely generous. >> what we have been saying on credit for a long time on credit is it is too extensive to buy

but too early to short. >> if you look at a basket of highly leveraged equities, they are underperforming. yet the fixed income credit markets are not that worried about it. so it is a really interesting disconnect and quite unique. >> high yields should be compared to equities. and certainly on a risk-adjusted basis, maybe even on an absolute basis, high yields are looking more attractive. >> if you start seeing lending standards being tightened and credit spreads widening on a sustained basis, you know you are going to create a feedback loop into equities and you are going to head into a recession. we don't think that is a story for the next few quarters yet. >> the u.s. recession still looks a long way away to me. and you would normally see credit starting to weaken, starting to widen if we were starting to deteriorate in the underlying growth picture. that is not there at the moment. jonathan: full house here in new york city today. joining me is rachel golder, cohead of yield and high loans at goldman sachs asset management, marilyn watson of

blackrock, and robert tipp of pgm fixed income. rachel, i want to begin with you. and ask you the question of the central of that piece. equity markets all over the place. yet, the junkiest part of junk is doing ok. leveraged loans are doing ok. why? rachel: you could either assume that equity is the beginning of the end and credit would catch down with it, or this is a flash in the pan and there will be a recovery in equity. we believe there will be a recovery, that actually the fundamentals of the credit market and the economy are still very, very 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 that the energy recession of 2015, 2016 really hit the reset button for corporate behavior for how the market was being addressed, and it really gave the market a chance to heal. so the quality of the market is not as dire as a lot of people have suggested. jonathan: you're not alone in making that point, that

high-yield had its moment a couple of years ago. do you share that view? marilyn: when you look at the high-yield market, there are also some very strong technical reasons why it has performed very well. we have heard them all before. the lack of supply versus demand, still strong demand for yields. i think you are still continuing to see that. you are seeing a bit of a shift. so you are starting to see better valuations in europe, for example. particularly if you use the fx component and convert it back to dollars, it is attractive now. so i don't think it has had its day, but the market is evil -- is evolving, and the fed continues to hike we will see that. jonathan: robert? robert: it has been a sleeper outperformer this year. it is a good environment. it is a u.s.-leaning market. the u.s. economy is doing well. while europe has been having its 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, maybe

because of the repatriation and share buyback, you have steep correction in equities spilling over a bit. but i think to the extent that this recovery, this expansion, continues, they are likely to reemerge as a sweet spot. jonathan: it would be disingenuous of me to say that credit has come out of this completely ok. we have seen spread widening in high-yield. the broader point is the outperformance has been the worst part of high-yield. the broader point is that leveraged loans have remained pretty much resilient. robert, to your point, if there are people watching right now worried about the equity market volatility and the big downdraft, is the message to them ultimately that the message in credit is not one of doom and gloom around the corner? robert: i think the leveraged loans are the hot area. that is the one 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. i think that it has definitely gone from a wholesale cheap fixed income market in credit that we had a couple of years ago. it is much more of a bond

pickers' market. you have to be very selective, whether it is peripherals, high-yield, emerging markets. and the most difficult to find, the ig. jonathan: can i pick up on the point that technically the leveraged loan market is strong. why is it technically strong? robert: we have two experts here, but retail demand is very high. and you have a fed rate hike environment. that has created a bulletproof technical for that market despite really high issuance. jonathan: rachel, are the fundamentals strong? rachel: the fundamentals are strong. the technical we need to mention also is the clo demand. so clo's are issuing at a phenomenal clip. they now represent over 50% of the holder base. and actually, 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 really, really good shape. they actually generated good returns. so i see the clo base as a

stabilizer, but also the demand from the clo's has created a supply that is actually relatively unique. the loan market has changed materially. the percentage of the loan market that is loan only has more than doubled in size in the last couple of years. you got weaker covenants and it has drifted down in ratings quality. i'm not saying we do not like loans. we actually still 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. jonathan: 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 will be, there is nothing beneath them. so what does all of this mean for recovery rates? a lot of people look at the historical analysis and say recovery rates are ok. they are good. is this time different? is it a different market compared to 10 years ago? rachel: yeah, we would expect it will be. you have entire capital structures composed of loans.

there is no subordination or first loss piece beneath the loans. so if historically the loan recovery rate has been as high as, on average, $.70 on the dollar, we would use the lower number. probably something around $.60 or below that. it also depends on how stressed the balance sheets are that you are seeing. now, we would say that overall leverage is not excessive, 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. and if you looked at a more reliable cash flow number, these companies might be somewhat more levered. so we think not only lower recoveries but also potentially more volatility. jonathan: robert, 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. i mean, the demand is strong. the clo demand is strong. but you need a really robust credit team to go into every deal. and if you have that, by the time we get to the next downturn and you have been very

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

interest rate rally. so in a raw return sense, i would suggest the high-yield. jonathan: you don't think we have seen post crisis heights in high-yield space? robert: i don't. i mean, i think i.g. is different. there are opportunities there, but when you adjust for everything, the spreads were incredible it had earlier this year. it seems unlikely we will go back there. in high-yield, if the fed succeeds in not killing the economy and we have a moderation in growth, and this goes on for a couple, few more years, i think the technicals could move the market quite a bit. jonathan: marilyn, do you share that view? marilyn: i think also as we move forward and the fed continues to raise rates, even if it is at a more gradual pace potentially, i think one other aspect to be aware of is the change in the size of the ig market, and the triple b space, how that has grown exponentially when you compare it to the double b space, for example. so as you get closer to

so recession or toward the end of the cycle, if you see some rating downgrades from triple b and the high-yield, it is a factor you need to consider as well. jonathan: a final word on credit, rachel? rachel: we have 7% yields in high-yield. i think there is a threshold that really matters to people. i think we have seen, with the rate rise, we can see further spread compression. we would be buyers of it into the end of the year. the technicals and fundamentals are looking good. jonathan: rachel boulder -- a bullish group today, i have to say, joining me alongside marilyn watson and robert tipp. coming up on the program, 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." ♪

♪ jonathan: i am jonathan ferro.

this is "bloomberg real yield." i want to head to the auction block now, where netflix was the headliner for the week in high-yield. the company sold more than $2 billion. it had to offer yields at the high end of the price expectations, though, the first time that has happened for one of the company's debt sales. elsewhere, u.s. debt investors are helping to finance the constellation brands' bet on the future of the weed industry. it sold more than $2 billion of bonds to help boost its stake in canadian weed grower canopy. and in leveraged loans, spacex is said to be working with goldman sachs to raise $500 million of leveraged loans. closely held, spacex's valuation has climbed to about $28 billion. this week, the former fed chair janet yellen joining the chorus of people concerned about the rise of leveraged loans. she said in an interview with the financial times, 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, big issue she has chimed in on and many others have as well. still with me, rachel golder, from goldman sachs asset management, marilyn watson from blackrock, and robert tipp.

robert, to come to you, i raised that quote because i am wondering whether former fed officials and current fed officials are trying to tell us something. the guiding light at the moment seems to be worries about financial assets and financial wobbles. robert: they are operating in a world of uncertainty. but they do know that what has ultimately cost the average american, and even more than that, are the big downturns. the crashes, and the crashes have been caused by the bubbles. those are the ones where the bulk of society recovers slowly. instead of being very cautious. i think it was probably five years ago she was warning on biotech, right? so i think it behooves them to kick the tires and see if anything rattles. but that is ultimately what i think what is going to extend this expansion, not seeing the widespread excesses of aggressive lending versus appreciated assets, the real estate bubble, or any gigantic single sector bubble, you are not seeing that but they continue to raise rates.

i think in the end, that is what will be very helpful to make sure the excesses do not build. jonathan: that is the former fed chair. current fed officials, one of them has warned this week about the leveraged loan market in a quite sort of emphatic way. the current fed chairman himself, 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 basically said the equity market volatility will not force them to pull back from their rate path, i'm wondering what the guiding light actually is for them now. marliyn: that is the $1 million question. they made it clear they are not sure where the neutral rate is. there is a clear job mandate. the economy as we saw today with gdp numbers continues to do incredibly well. we are still seeing some very strong data coming through, for example from consumption data.

but we are starting to see, though, the impact in the housing market on other rate sensitive sectors, such as the auto sectors, etc. so we are starting to see where rate rises are having more of an impact now. so i think, especially as we get through sort of the next year, and the committee has less of the consensus around two or three or four hikes next year. then the question becomes, at what point do they pause and at what point do they start to go on a meeting by meeting basis rather than consistent, gradual increase in rates? jonathan: we are seeing some tensions start to emerge in a more material way, and that tension is between the market pricing, the federal reserve interest rate hikes, and where the fed essentially is telling us where they are going to be. even this week, a slight repricing 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 the 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 at any time, and now it looks as though powell is trying to dial down the reliance on the sort of 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, decent inflation but not an immediate threat of inflation breaking out to the upside. as we go into 2019, i would agree very much with marilyn. there are a number of other forces that are going to 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. so as we look among other things in the difference between the performance of the equity market, which has been very weak, and the credit market, which has been somewhat stronger, i think it relates to the expectation of slowing topline growth.

you have slowing topline growth. if margins then begin to erode, you will see leverage worsening. this is just one of the pieces in the puzzle of tighter financial conditions, and that will influence the fed's hand. it is just not immediate. jonathan: you mentioned inflation. i think that is important. inflation expectations, are they starting to roll over a little bit? look at the breakevens on a five-year maturity, you start to see some signs of that happening. robert: today, you are seeing it. but it is surprising how little they have come down given how much energy has come off. and the curve is incredibly flat, which suggests the market does not really have a strong view about where it will be headed in the long-term. i think that on the fed, when you look out a year or two, and the fiscal is fading, and presumably energy prices will crush and begin -- crest and begin to go horizontally as they go through the various service areas -- 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 really sure they need to do it. jonathan: do you think they are 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. but you are just beginning to see in new home sales, in particular, a correction which has extended a little bit further. i mean, there have been waves in the rise the last handful of years. this one is beginning to be longer than the ones before. so your interest rate sensitive sectors are beginning to bite. and they are thinking they have two or three more moves before they need to slow down. maybe they need to slow down a little sooner. jonathan: guys, you are going to stick with me. robert tipp alongside rachel golden and marilyn watson. in the markets this week, a check on where treasuries have been. twos, tens, and 30's. treasury yields shaping up as follows -- treasuries receiving a bit on the front end. down by 10 on a u.s. 10 year,

and down to 332 on a 30 year. still ahead on the program, the final spread. the week ahead featuring two major central bank rate decisions and payrolls report around the corner. from new york, this is "bloomberg real yield." ♪

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

on treasuries. are we getting to the point where we are seeing that move now and we could be close to the peak? marilyn: we still like the front end of the curve. we think that it might be from here pretty well anchored. but actually if you continue to hold that, we think it is very reasonably priced in now, the number of hikes you might have. whereas i think potentially the next move could be more of a steepening, particularly if the fed does indicate it will pause its rate hiking cycle. at the front-end, you will still have a lot of cushion, you will still get some good income. even if yields go up more, you are still cushioned. whereas further up the curve, if you go to 10 or 30's, there is just no cushion. there is no question. jonathan: walk me through that, why the next big move could be a steep one and what the catalyst will be for it. marilyn: if the fed announces it will pause at some point, the market is not prepared for that. we have seen some movement and a few signs the market is more concerned, but it is not yet priced in the fed might pause

sooner rather than later. they potentially will raise rates in december, but next year, i think then the market will really start to reassess the end of the rate hiking cycle, reassess its view of the u.s. in relation 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 that now you can see foreign investors going elsewhere, going to europe and elsewhere and getting better yields. jonathan: robert, 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. you know, the fear with trump coming in was that they would extend and might want to do ultralong treasuries and so on.

instead, they had a course change late last year, where they moved supply heavily to the front end of the treasury curve. they have been pounding that and introducing new maturities on the front end of the curve. hitting it with supply. bond has been a spectacular performer until lately. i think now, your performance spot is between fives and 10's. at this point, it may be too early for 2's. you know, 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 3% or above 3%, 2's may still have some downside. but at that point, you will probably be inverted. jonathan: guys, we have to wrap it up and do the rapid fire round. you know how this works. quick final questions with quick answers, if you can. will credit still lead equity going into the next downturn? is that where the towel is? will credit still lead equity going into the next downturn? yes or no? rachel? rachel: yes. marilyn: yes. robert: yes. jonathan: have we seen the post crisis hikes on u.s. high-yield? rachel: no. marilyn: yes.

robert: i don't think so, no. jonathan: that is really interesting. is the fed put a thing of the past? yes or no? rachel: no. marilyn: yes. robert: no. jonathan: interesting stuff, guys. thank you for joining me over the last 30 minutes. my special thanks to rachel golder from goldman sachs asset management, marilyn watson from blackrock, and robert tipp from pjm fixed income. that is it for us this week. we will be back in new york same time, same place. friday, 1:00 in new york. 6:00 p.m. in london. for our audience worldwide, this was "bloomberg real yield." this is bloomberg tv. ♪ .

comcast business built the nation's largest gig-speed network. then went beyond. beyond chasing down network problems. to knowing when and where there's an issue. beyond network complexity. to a zero-touch, one-box world. optimizing performance and budget. beyond having questions. to getting answers. "activecore, how's my network?" "all sites are green." all of which helps you do more than your customers thought possible. comcast business. beyond fast.

♪ carol: welcome to bloomberg businessweek. jason: tom barrack has been shut