jonathan: bloomberg "real yield" starts right now. ♪ jason: fueling -- jonathan: fueling global growth fears. leverage loan funds suffering the biggest outflows on record and the fed 2019 plans in the balance ahead of next week's decision. what does the fed do when 2019 looks increasingly uncertain? >> pause. >> the fed is going to pause. >> pricing in one hike.

>> two more next year. >> whether this is one more hike or three more hikes. >> i would be pausing until we had a sequence of inflation numbers above 2% at the minimum. >> we have a situation where the fed has reversed course and raised rates. the $50 billion a month in the balance sheet is important to markets. >> neutral is not 2.5%. one person at the fed believes it is 2.5%. we are just below the bottom of the range of where neutral might be. >> i am waiting for validation from the fed they have changed direction. thethan: joining me around table is the cohead of fixed frome -- plus coming to us edinburgh is luke hickmore. great to have you.

is next week's decision really that much in the balance? it is not much in the balance because the market is expecting it. there will be a hike, but the comments will be dovish. the question is how dovish will they be in 2019? >> i think the markets completely reinterpreted anything by the fed. how about the fact growth has started to slow a little bit after years of being strong and we are going back to trend line? it is not either or. the fed should not commit because it should be somewhat data dependent. >> you are saying this is a market struggling to draw distinction between -- >> the yield curve is telling you the fed has already gone too far. recency biasour

and came down from mars after 20 years and saw where the growth is an unemployment and inflation taking up, you would say we should be above normal. raising the real question of why this market cannot tolerate that level. >> wages haven't really started to accelerate. they have gone up a little bit and employment has been strong. i think we get one now and two next year and it will feel more said. start, stop i think they will wait to see if they need to do more. i have a sneaking suspicion we may end up looking back and saying of course it was four interest rate rises. jonathan: my big struggle is reading the economist notes going in basically saying the same thing, a dovish hike and map -- my response is relative to what?

right now, there is nothing priced in the market. how can you dovishly surprise the market when you are priced in anyway? kathleen: you have got to maintain a dovish commentary are transitioning away from the central bankers being in control. draghi just says his goodbye to bond buying. that means it is all in the politician's hands. i continue to believe what they are really doing is talking the dollar down. a lot of the problems are hitting companies right now. it's more about the dollar and the more dovish they are as they say goodbye to controlling the market, they are going to continue to weigh on currency. jonathan: i think it is interesting to think about the european central bank hiking interest rates when the federal reserve isn't going to be much -- doing much at all. -- ere joined last week

>> even if the fed work to go to or three times, the fear was as the ecb was thinking it was 2019, it would be a difficult proposition given the fact the u.s. economy is slowing down. there is a chance of the fed might pause after the december meeting and that complicates policy for the ecb. , if the: luke hickmore fed will struggle, what does it mean for the ecb? luke: it is difficult for them. i guess they would like to start hiking rates before the fed takes them down again and the risk is that doesn't happen. by the time we get an ecb rate hike, mario draghi will be gone. this doesn't feel like an environment where you get a rate hike next year. i actually don't think we get anything from the ecb until we are well in to 2020. jonathan: you have got to talk

about this relative to the market. we have cleaned out a ton of shorts in the treasury market. we are just half of 290 -- just south of 290. cork government bonds are going looking rich and pricing in rate action. does that mean we are primed for a move the other way? goshren: forecasting rates is difficult. jonathan: tactically speaking, are we set enough? goshren: i think the volatility will be a cause of what happens in the equity market. for a long time with nominal growth both 5%, why does it make sense to have a yield at 3%? if you think you are going to get nominal growth of 25 basis points a year in europe, we are going to have big problems. kathleen: i think what is weighing on the market is uncertainty and you could move into 2019 and side -- see either

and inflation surprise or something that moves the market that is not factored in right now. jonathan: are you picking up tips? kathleen: absolutely not. jonathan: you think you might get an inflation surprise, how do you set for that? kathleen: i am total return. kathleen:i would look away from the rates market for opportunities to increase gershon: returns. gershon:can i say something about draghi? he is a magician. jonathan: you think so? somehow he gets away with being able to give us basically no information. we are parsing every word chairman powell says and when it clue to draghi, we have no . what i found interesting yesterday was in the q&a when asked are you out of things in your toolbox considering we are late in the cycle and you haven't started to raise rates and he was adamant they think qe is a permanent part of the

toolbox and in the next crisis they would be willing to go effectively even lower. jonathan: do you really think he got away with it yesterday? jonathan: look at the markets. every time we think it is ridiculous for 10 year bonds -- it seems to just not move. kathleen: what will be really interesting is what is china going to do? part of the uncertainty is the trade tension. the u.s. has leverage in the short-term and china is worried about slowing. they will open up the stimulus's wayit again in a targeted and that will change everything for the global economy. jonathan: at the moment, there have not been big signs of it. subtle signs they are leaning towards an easing bias. do you think they get bigger? luke: i think the ecb has things they need way and that will change everything for to sort out and it doesn't feel like an environment where they really need to

tighten up. trail for italy or you could run into a credit crunch certainly by 2020 in italy and into a tough economic environment for italy as it exists today. the data out of france didn't point exactly to an economy that can really live within much in the way of tightening. the ecb moving to more of a dovish stance over the next few months seems like a pretty easy call from here. jonathan: you are going to stick with me. gershon distenfeld, kathleen, and luke hickmore. high yield in issuance continues, reaching a level we haven't seen in a decade. this is bloomberg "real yield." ♪

jonathan: i am jonathan ferro and this is bloomberg "real yield." more than $220 billion worth of treasuries were auctioned off this week. i want to focus on the $16 billion, the offering received strong demand and had a primary dealer award of 22%, the second lowest on record. tesla planning to offer more than $800 million of bonds backed by auto leases and found strong demand for the inaugural bond sale in february and the company plans to become a regular issuer. in the u.s. high-yield issuance, there is a drought. december would be the first month of no issuance since november 2008. still with me is gershon distenfeld and caffeine -- kathleen gaffney and luke

hickmore. your thoughts on that stack in high-yield. where is the supply? kathleen: there is no supply and high-yield managers are feeling the pain and reaching for yield. there aren't a lot of choices. that makes for some not so great decisions in the long run. gershon: i think the issuance has gone two places. -- yields were low and spreads were tight issued and a lot of companies went and issued the loan market because financing was much cheaper and you did not have to give traditional covenants. jonathan: what i would like to learn is put these outflows in perspective. a lot of hyperbolic language around all of this. the biggest outflows on record. how important are some of these neutral funds we are tracking to the overall universe? gershon: i think it is so much more important than loans because it takes three or four weeks to settle a loan.

having outflows that are 2%, 3%, 4% of the market is scary. what happens if we get 10%, 15%? most trades, you do the money and -- you get your money into or three days. i worried we will hear liquidity issues. jonathan: let's talk about that, luke. a lot of retail has been getting access to things that are not liquid, but give the illusion of liquidity because you can buy the etf. luke: i have had a problem with that for the long time -- a long time. iguidliquidity on an ill asset class. investors are little bit late to that trend. you can run into problems further down the line in the market can get very gappy in funding outflows. the price that will be offered as we get further and further into that liquidity crunch in

-- we areloans watching very carefully. kathleen: i could not agree more in terms of gappy. etf's are important, but you have foreign investors and the cielo -- clo machine. see that changes and you supply demand come out of balance, who are you going to attract? there are a lot of new investors in and the ones that are going to come in are probably more like me, total return looking for much bigger discount than that market has seen since 2008. gershon: there is another factor at play. i have heard high-yield has done better than loans on the upside, wait until the downside, they are senior secured. part of the reason investors are fleeing is because the credit quality isn't nearly as good as it used to be. asset coverage is not as good as it used to be. we should expect more results

and lower recovery in history. the drawdown so far is about 2% in high-yield and 3% in loans and we think loans will continue to underperform. jonathan: institutional money is not too worried about what is going on. they are saying, we will see outperformance relative to high-yield. i haven't seen the capitulation yet, have you? gershon: not from institutions, but they are much hot -- much heavier in bonds. we have been through a partial cycle already. look what happened in the energy space and this trip in oil. a very unlike 2015 and 14 when you had these companies with tremendous amount of debt in the balance sheets. those companies over structured. what is left is much more able to withstand lower commodity prices in general. jonathan: it is intriguing that credits are finding a floor and leverage loans are rolling over

and some people might say it is the rate story. loans are priced off libor and that is climbing higher. what does that signal if libor is climbing high and loans are rolling over? kathleen: it is climbing higher and that is end of year liquidity to some extent. it is not expected to move that much higher. the interest in capturing that spread may not be sustainable through early 2019. i think what we are seeing is convergence in the long-term defining high-yield differently, that it won't just be asset classes anymore. jonathan: i am trying to take the other side again the heads of people that are leverage long -- the flows showing up and the outflows in the last couple of weeks are basically the poorest --tourists. this will play out for a couple of weeks and months and then it will settle down.

is there anything in that, luke? luke: i think you could make an argument that that is the case. the problem is it is about the flow, as it always is with these instances and illiquid asset classes. who will support the market when it starts looking cheap? i think as you continue to -- flows, there is a risk. it will be lower before you see the institutions stepping in. the settlement is at issue, the legal issues are difficult. these are not easy instruments and they tend to be issues because it is cheaper than the issuer rather than good for the person lending the money. jonathan: i think you just to find 20 and much of what happened with loans with that last line. gershon: absolutely. you are technically correct that

they price off libor. in reality, they don't. a libor has gone off 200 basis points and alone has gone up over a hundred. when people are throwing so much money -- it will not happen on the downside. you don't get the full increase on the upside and you do on the downside. jonathan: it is a really good point, thank you for bringing that up. gershon distenfeld, kathleen gaffney, luke hickmore. we want to get a market check. yields up just a couple of basis points, three basis points on a two-year. spread, ad, the final really busy week ahead featuring central bank decisions from around the world. this is bloomberg "real yield." ♪

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jonathan: i am jonathan ferro. of this is bloomberg "real yield ." we will get interest rate decisions from around the world including the federal reserve, bank of england, and the bank of japan. we will keep an eye on u.s.-china trade talk and the governmentther u.s. shutdown. still with me, gershon distenfeld, kathleen gaffney, and luke hickmore. a lot of people talking about liquidity, illiquidity -- talk me through why that is so significant at this state of the cycle? gershon: i think we over emphasize liquidity in the short run in general as it relates to the end investor. we talked about having continuous liquidity in etf. most investors should not have data liquidity. a think it hurts. professional managers i want to move their portfolio around, if

there is not proper liquidity, it will be costly. jonathan: size matters here? kathleen: size definitely matters here. being nimble is a great advantage. when you are large, it is difficult to make meaningful moves. jonathan: your thoughts on this subject? luke: i think it depends what instruments you have got available to you. there are more liquid instruments than physical cash and size doesn't always cause a problem when that is the case. it depends on the makeup for your funds and the mandate in so many different factors. we have not suffered too much from a liquidity problem in our fiscal funds this year, but we build up the amount of liquidity we have for sure. ,onathan: talking to you guys it is a very constructive tone about what comes out of 2019. i want to get an idea how difficult it is to manage money win a lot of clients at the moment are very nervous about what 2019 brings and what do you

communicate with them when you pick up the phone and start calling? gershon: we point out that with the exception of trade, we were seeing all the same things at of 2015. we are due for a recession and late in the credit cycle and the fed will screw things up for us. the reality is price matters and maybe we are closer to all those things, but we also have yields higher almost across the board and it will take probably a recession to end up having probably the negative returns we have seen in fixed income. kathleen: i think that is a valid point. the fundamentals are positive, so it will be tough to get a systemic credit event in the markets away from loans. it does give active managers a real opportunity with specific risk. thesee seen the ges -- specific companies that have issues and that is where the liquidity plays into long-term

investors' hands. luke: i guess you have to be really careful because there are not many times when credit gives you a negative return for two years in a row. he would have to look really hard for that to happen in history. yes, event risk will be important, but it is hard to play from the long side. we would be cautious about that going into 2019 for sure. jonathan: a sensible, constructive task from -- tone from all of you. let's get to the first question as we look ahead to the federal reserve decision. ken powell deliver a -- can powell deliver a dovish the price? gershon: no. kathleen: no. luke: not a surprise, no. jonathan: can the ecb deliver a hike before he leaves? gershon: he could, but i will say maybe. kathleen: no. he leaves in october, so

definitely no. jonathan: i have an idea on where you stand on the following question. the outperformance in 2019. does it come from leverage loans or high-yield through 2019? gershon: not even close, high yields. essentially double-digit returns next year. jonathan: really? gershon: yeah. kathleen: high-yield. luke: high-yield for sure. jonathan: i have got an idea where the consensus is. great to catch up with you all, gershon distenfeld, kathleen gaffney, and luke hickmore. from new york, that does it for me. this was bloomberg "real yield." this is bloomberg. ♪

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