jonathan: from new york city for our viewers worldwide, i'm jonathan ferro with 30 minutes dedicated to fixed income. this is "bloomberg real yield." coming up, the federal reserve teeing up aning to fourth rate hike in december. even as global growth concerns are increasing, fueling a bid into treasuries and crude oil falling into a bear market. we begin with of the big issue, the fed staying the course. >> i would expect the fed's projection of gradual increases in the target funds rate to stay on track. >> the economy is cooking, baby.

come on. you have fiscal policy going on, the lowest unemployment rate since the 1960's, and the economy is doing nicely. who is tightening policy? nobody in the world is because their economies are getting crushed like bugs. >> there is no reason to keep tightening at this pace, especially since we're doing it twofold. i think one of that has to slow down. either in terms of hiking or the balance sheet. >> slow down? come on. if it were slower, it would be reversed. give me a break. four rate rises of a quarter-point per year? that's 1%. they started in 2015. >> if they start to see the curve invert or really flatten toward zero, i think they are going to back away. i do not think they will play chicken with the market. jonathan: joining me around the table here in new york city is henry peabody, mary bowers. plus from london, a portfolio manager at algebras investments.

mary, i have to begin with you to see if you disagree with your colleague. david bloom. mary: we are thinking the fed will remain on pace with the rate hikes. the one thing from a high-yield perspective -- i have been fairly cautiously optimistic on high yields from a fundamentals perspective. we were a little more cautious this summer from the valuation perspective. we repriced about 50 basis points in october, but we are starting to see concerning things bubbling from bottom up in terms of supply chain disruption and cost increases while top line is starting to slow. it feels like putting plugs in the portfolio. every sector seems to have a little bit of issues. that is keeping us, despite the repricing, still concerned. now more from the fundamentals perspective. henry: i think it is spot on. and i think a little about the inflation risks being to the

upside, and we are still quite stimulative on the front end. we are talking about moving up to neutral, 3%. we have a ways to go. what happens if wage inflation pushes into the high threes and productivity stays around 1%? then all of a sudden you have even more expansionary policy. the yawning deficit at this point in the cycle is something to pay very close attention to. so the fed has its work cut out for it. especially with a leverage in the economy and having to walk that line. it is a tough gig. jonathan: it is a really tough gig, but i thought it was interesting in their statement they barely acknowledged anything that happened the past two months. what did you make of that? >> i think they are trying to overlook the volatility of the market. i think the fed knows there is little dry powder left if there is another slow down in the next three years to five years. and they have to build a policy buffer. the fiscal policy ammunition will be limited because it is used already late in the cycle. so they want to increase the

potential for tightening -- sorry, for loosening policy in a slow down. having said that, if you strip out the cost of housing from inflation, wages are growing, but inflation is still relatively muted. we do not have the pass-through you had in a normal recovery between wages and inflation, between low unemployment and inflation. you could see if the next year the momentum of the fiscal stimulus fades, you could see the fed looking at itself and maybe saying, we hiked too much. we are far from that moment. henry: building on what was said there, in early october we had the powell comment about being a far, a long way from neutral. jonathan: we do not know what neutral is, but we are a long way from it. i am with you. henry: we are building and a -- in a little bit of buffer and it adds to the fragility in equity markets.

markets and credit. they said they will not bailout bad positioning. jonathan: perhaps they should not. most people watching this program will conclude that they should not. if you look outside, doggedly looking at unemployment and inflation, there are often things turning on in this economy beyond what many would consider lagging indicators. there are things happening now you need to be focusing on now? in the market? in the economy? mary: where we are seeing it is autos, auto parts. homebuilders have been the underperforming sector in credit. in october, we also saw the basics start a selloff even more. so we have seen, again, cost pressures and supply chain disruption, everything we still have uncertainty around where the next wave of tariffs might come. are we going to reach an agreement? that still seems a way off from our perspective. jonathan: alberto touched on something really important. i want to come back to you. it is not about having a conversation week after week on programs like this about what the federal reserve should and

should not do. it is what they will do. and they are communicating pretty clearly to us at the moment, they are going to carry on hiking, aren't they? the conclusion is they will carry on hiking until something breaks. alberto: yeah, this is the worry. you carry on hiking, but at the same time, structurally the economy globally, and the u.s. economy, has been more fragile. the has been more leveraging in the corporate balance sheets. markets have been one way for 10 years. there is more liquidity mismatches. and regulators have been focusing a lot on banks, which were the channels of contagion for the last crisis. they are not necessarily the issues that are potentially going to be affected in the next crisis. you know, the next crisis could be about higher real yields, the lack of liquidity in markets, high-yield balance sheets and so on. so it could look like they are overdoing it, especially for emerging markets and other economies that are dependent on

dollar funding next year. henry: i think the dollar funding issue is a real one. we saw a shift in late september when that became more of an issue. and let's think now about technicals out next year. we could see capital flowing from the u.s. back to europe. if you see a shift in the ecb policy, there could be a bit of a sucking sound into europe now that they have been priced out of u.s. markets. so i think that is a technical aspect that a lot of people are not talking about. jonathan: let's talk about fundamentals. xus. i see deceleration and growth across europe. i see it more clearly this week in china as well. how do you get the sucking sound when the momentum is not there in the united states? henry: everyone has been looking for china to slow, and china is doing everything they can in their power to avoid a rate cut and push as much as they can. but we have to think about second derivatives here. we have had a push towards the deflationary mindset for a long

time. it takes a lot to dislodge that. even if the ecb pushes up rates 25 basis points in q3, recaps the italian banks to a degree, brings them back into their camp, that is a big change in risk attitude over there. so i do not think it takes a lot to shift from a zero to actually flows returning. jonathan: if you get outflows, where from? where is vulnerable on the treasury curve for you, the way things are priced? henry: you saw that auction on tuesday, it was a really ugly auction. you have a bid today, but the treasury curve -- the high-quality debt space, whether it is u.s. high grade or treasuries, seem vulnerable to us, between supply, refinancing, correlations, the fact that japan and china, the two largest buyers of treasuries, are starting to get along better. that is business school 101.

that is something to pay very close attention to. jonathan: mary? mary: all year, we have not seen that bid from overseas that has really fueled inflows over this credit cycle. a lot of it is the dollar cost of hedging. if you look at euro high-yield hedge back into dollars, it is almost doing better at this point, given that we do not have some of the same bottom-up issues maybe from a sector perspective. so that is a risk, and i think that is a risk, like you said, for investment grade and high-yield. jonathan: i want to put that question to someone in london. someone outside the united states. will we get that sucking sound, those outflows through 2019? alberto, from where you're sitting, what does it look like? alberto: in the emerging markets and the u.s., there have been some outflows, but the area which really has suffered this year has been europe, which is gone from euphoria last year with the french elections,

president macron, the dream of a united europe. the this year, with the italian coalition, we have come back to the opposite extreme. the pendulum has swung towards europe breakup fears again. we think the market is now priced for extreme fear risk. it is priced for if aliens go back to invade earth, first thing they do, they will attack europe and the european banks. so where are the loans of 2016, the record high in spread premium between high-yield bonds in europe and u.s. held bonds for the same rating since 2010. here, you have to think about the european side has been a lot slower. companies are still deleveraging, they have not done that spur of m&a, and you are getting pretty high spreads for medium or good-quality high-yield companies. if you don't have a recession, which is really what the market is telling you is going to

happen, if you do not have a hard brexit, if you kick the can, you get paid very well. we are talking about 6% and 7% yields in euros. which are equivalent to 8.5% to 9% in dollars. jonathan: have you been increasing exposure to italian bank credit over the last month? alberto: we have reduced some european exposure in q1, and after the summer we have been buying. italy obviously has long-term issues, but you have the same spreads, the same returns in spain and the u.k. as well. you have barclays debt trading wider than latin american countries, which have elections and a very unsustainable debt burden to give you an idea. there is an extreme premium, and that's potentially an opportunity. if you look at emerging markets or the u.s., valuations are not as wide as in europe.

jonathan: guys, great to have you with me, alberto gallo, henry peabody, and mary bowers. coming up, the auction block. spacex is set to change its $750 million leverage loan. that conversation is 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 we start with more issuance from the u.s. treasury. a ton of issuance this week, but the one that made a lot of news was the $19 billion of 30 year bonds with a bid to cover ratio that hit the lowest level since

2009. it was awarded at a four-year high, at 3.42% above the bidding rate. on the corporate side, this past wednesday investment borrowers posted their biggest supply total since early october. volkswagen led the way with an $8 billion, seven part deal, just shy of $60 billion. and in leveraged loans, spacex is planning to launch a $750 million loan, which will now be led by bank of america. goldman previously led talks on a smaller $500 million financing. still with me to discuss these issues is henry peabody, mary bowers, and alberto gallo from algebris. mary, many people might have missed it. especially if you are outside of fixed income. for leveraged loans, it was the busiest month since may, in october. that was october, where everyone

was going crazy, and that market was still that busy. how? mary: they posted a small positive return in october. it outperformed much of fixed income this year. up 4% year to date. clo demand has been enormous. we had over $100 billion of clo issuance so far this year, and it is sucking the newest supply issues out of yield out. we had talked about new issued supply out of high-yield, which we have talked about in the past. the technical for high-yield has been pretty good, despite the outflows we had for the markets. for now, it seems like the leveraged loan space is still going to be able to print a lot of new issuance. jonathan: is that attractive for you? mary: we think it is getting a little frothy, frankly. it is not just the terms. there is a lot that is discussed around covenant light. that has been around a long time, but frankly, we are seeing very top-heavy secured cap structures, and what ends up happening in the next cycle, it is going to erode the recovery values that have typically been pretty high for leveraged loans.

at the same time, we had been saying throughout the year that the fundamentals look pretty good for credit, and while we have seen some choppiness in the third quarter, i would say that we aren't rolling over. it is certainly getting late in that cycle, and we are seeing some speculative issuance. jonathan: on the leverage loan side of things, how is this attractive? from a floating rate perspective or a credit perspective? henry: we have a number of strategies that are focused on loans to our strategies, which are very much focused on total return. for us, it is not a great spot. i think the attraction is the floating rate component, the secured component. those are the textbook assets to it. -- those are the textbook 101 aspects to it. let's look at the combined high-yield loan market as a whole. the composition of that market is changing dramatically. we are doing top-heavy capital structures. you have more in the second lien space. big participation by clo groups and retail involved. some of the attraction is

everything else is expensive. it is very easy to go, it's comfortable to go someplace with a floating rate aspect to it. what happens when something becomes less expensive, or the high-yield cells off and equities are 20% down and the flows reverse? i would leave that as an open question. because liquidity, we will see how the market responds and how we can absorb that liquidity. jonathan: and how much liquidity is in the leveraged loan space. alberto, how would you manage exposure to u.s. leveraged loans right now? alberto: we think there are more attractive parts of the market. asset classes have done really well this year. like you said earlier, if you have a repricing of yields across short-term interest rates from the fed, longer-term interest rates going up in real terms, other asset classes will be attractive. one interesting point is that a

lot of investors think leveraged loans are good because they have a floating rate component. so they don't get hurt by duration. however, from a credit point of view, some companies will get hurt by higher financing cost. if rates go up, you do not have an immediate mark from the duration component, but you could have higher refinancing costs for companies, which can get hurt from their balance sheet weakness. it is not immune from an increase in real yields. jonathan: a straightforward points, but an important one. borrowing costs are going up. mary: borrowing costs are going up, and where we are seeing some of the m&a froth coming into the market was from pre-leveraged lbo's. it is certainly still a small part of the issuance, but it is something to keep in mind, particularly for top-heavy cap structures. you are going to see particularly where you have a

high-yield bond, a fixed-rate bond, and as credit improves, it can requalify at a lower rate. you have a top-heavy capital structure with a lot of floating rate debt, as your debt moves higher, your cost is moving higher at the wrong time. that is something we look at, when we look at our own positioning, very mindful of some of these top-heavy security cap structures. jonathan: guys, you're staying with me. henry peabody, mary bowers, and alberto gallo. let's get you a market check on where bonds have been this week. two's, ten's, and 30's, yields shaping up as follows. up on the front-end by two basis points, but a bit into the 30 year, even with that ugly auction this week. yields lower this week. 3.40 on a u.s. 30 year. the week ahead, featuring a fresh read on u.s. inflation and comments from both draghi and powell. this is "bloomberg real yield." ♪

jonathan: i am jonathan ferro. this is "bloomberg real yield." it's time now for the final spread. coming up over the next week, we will have speeches from jay powell and mario draghi. plus, we have an opec meeting, key economic data from the united states and china, and italy will show its new 2019 budget to the european union. a reminder, the u.s. bond market is closed monday for veterans day. still with me to discuss is henry peabody from eaton vance, mary bowers from hsbc global asset management, and alberto gallo from algebris investments. mary, we have to get you on the oil market. there was an opec meeting through the weekend, and we see a big move lower in crude, can high-yield stay as resilient as it has done amidst this move lower? mary: what we see now through the workings of the oil market and the high-yield cycle, we saw the cycle in high-yield.

-- the new default cycle in high-yield. that flushed out a lot of the lowest credit quality in energy. yes, what we have left are a couple of bad actors, but by and large, the credit quality is much higher, and they can withstand lower prices of oil. henry, is that you take? we have had these stress tests, are these companies better? henry: you washed out a good deal of the market. on oil, one of the interesting things about it is this iranian situation and how trump has given outs to several nations ahead of the midterms. i think he knew he could not have $3.75 gas going into the midterms. but the midterms are behind him. he has a year or so before he needs to worry about his reelection. he can actually put the boot to iran a little bit more. watch for higher prices. he actually has the ability to do this now. jonathan: you are a bit more constructive on crude, do you need that to be constructive on high-yield?

or is that a big factor at the moment at all? henry: no, i do not think you need the crude story for high-yield. it is a technical story. we discussed that a little bit, so watch for those technicals to potentially unwind and give you an opportunity to buy duration and the ability for these credits to improve and back into their balance sheets, which they cannot do in the loan market. jonathan: that is a good point. you know how we end the program, you get into the boxes, and we ask you quick questions of the rapidfire round, we are going to do that now. we want to get to the federal reserve. a lot of people wondering where -- when the fed funds rate so peak. more than three or less than three? henry, more or less? henry: more. mary: more. alberto: more. jonathan: how do they fit into the 30-year through the week, yields are lower. some people out there might be considering to add duration. is this the time to increase duration, yes or no? henry? henry: no, not in the least bit. mary: no, no yet. alberto: not yet. jonathan: getting a consensus from you guys.

final question. and get a feel for where this is going to. will the oil route catch up with high yields? yes or no? henry: high yield is going to be softer, but not because of oil. mary: agree, yes. jonathan: alberto? alberto: i think high-yield is weaker, but not too weak. jonathan: a clear consensus, guys. i will work better next week. great to catch up with you. henry peabody, mary bowers, and alberto gallo from algebris. from new york, that does it for us. we will see you next friday at the same time, 1:00 p.m. new york, 6:00 p.m. london. this was "bloomberg real yield." this is bloomberg tv. ♪

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