ferro,i am jonathan bloomberg real yield starts right now. coming up, fueling global growth fears. data from china and the eurozone. trouble in paradise. in the feds 2019 plans balance of ahead of next week's decision. we begin with a big issue -- what does the fed do when 2019 looks increasingly uncertain? >> the fed is going to pause for the time being. >> one hike next year. >> there is a debate going on.

>> two more. i -- untilpausing if we had a clear sequence of numbers. >> we have a situation where the fed has reversed course. it does not yet as much airtime but the balance sheet is really important to the markets. only one person at the fed believes 2.5% is neutral. we are at the bottom of the range. i am waiting for validation from the fed. they have somehow changed direction. at the moment, it is not clear. >> joining me around the table is the cohead of fixed income. -- and comingtor to us from edinburgh is the investment manager at aberdeen standard investments. good 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 miss it -- misinterpret anything said by the fed. how about the fact that growth has started to slow after years of being strong and now we are going back to trend line. it is not either or. the fed should not commit because it could be's -- it should be somewhat data dependent. >> a return to trend growth and recession. >> look at the yield curve -- it is telling you that the fed has gone too far. if you drop your bias and you

came down from mars and you saw where growth is an you saw unemployment is at almost zero. >> why can the market not tolerate a 1% real rate? whenever we breach that level, things start to fall a lot of dead. -- start to fall out of bed. more like a stop start fed. i think they will wait to see what the reaction is. they will wait to see if they need to do more and i have a sneaking suspicion that we may look back and say it should of been four braces. -- raises. now, there is nothing

priced in this market for 2019. you cannot definitionally -- dovishly surprise but you have to maintain a dovish commentary because they are transitioning away from the central bankers being in control. draghi said goodbye to bond buying. it is all in the hands of the politicians. i continue to believe that what they are really doing is talking the dollar down. a lot of the problems are hitting companies right now. it is more about the dollar and the more dovish they are as they say goodbye to controlling the markets, they are going to continue to weigh on currency. bank, european central can they hike interest rates through 2019 while the federal reserve will be doing not much at all. even if the fed were to go to

or three times, the fear is that if the ecb was thinking it could hike rates in the second half of 2019 it would be a difficult proposition because the u.s. economy is slowing down. now, there is a real chance that the fed might pause after the december meeting which really complicates policy for the ecb. is going tod struggle, what does that mean for the ecb? >> it is difficult for them. i guess they would like to start hiking rates before the fed does. the risk is that it does not happen. by the time we get an ecb rate hike, draghi will be gone and growth will be gone in europe. this does not feel like an environment where you have a rate hike at all the next year. i don't think we will get anything from the ecb until well

into 2020. >> we have cleaned out a ton of shorts in the treasury market. on the 10 year yield, we are right near to 90. core government bonds are going into 2019 looking pretty rich. pricing out a lot of inflation. are we prime for a move the other way? >> forecasting rates is very difficult. >> tactically speaking. >> i think the volatility is going to because more by what happens in the equity market than anything else. , with nominale growth, above 5%, why does it make sense to have a 10 year yield at 3%? if you think that you're going to get nominal growth of 25 basis points a year in europe, you will have really big problems. >> i think that what is weighing on the market is uncertainty and you could move into 2019 and see

orher an inflation surprise something that really moves the market. that is not factored in right now. >> are you picking up tips? >> absolutely not. >> how are you positioning for that? >> who wants to take a week or return anyway. -- weaker return anyway? >> may i say something about draghi? he is a magician. somehow, he gets away with being able to basically give us no information. word thatsing every chairman powell says in the us but when it comes to draghi we have no clue. what i found interesting yesterday was during the q&a when they asked him if he was out of things in his old box. box and he was very adamant that he thinks you be --

the toolbox.of >> many people walked away yesterday quite worried. >> look at the markets. it seems to not move. >> what will be interesting that we haven't talked about is what will china do? part of the uncertainty is a trade tensions. theu.s. has a leverage in short-term and china is worried about slowing. they will open up the stimulus spigot in a targeted way and that will change everything for the global economy. >> at the moment, there have not been big signs that they are leaning. will they get bigger? i think the ecb has some things it needs to sort out on the agenda for next year. it does not feel like an environment where they need to tighten up.

you could run into a credit crunch in the next year, certainly by 2020 in italy and a tough economic environment in italy today anyway. and the data from france today did not point towards an economy that can really live with much tightening. the ecb moving towards more of a dovish stance in the next few months seems like a pretty easy call from here. >> you are going to stay with me. coming up on the program, the auction block. the drought in high-yield issuance. reaching a level we have not seen in a decade. that conversation is coming up. this is bloomberg's "real yield."

jonathan: i am jonathan ferro and this is bloomberg "real yield." i want to head to the auction block now, where 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. elsewhere in corporate, tesla planning to offer more than $800 million of bonds backed by auto leases. it 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 severe drought. december would be the first month of no issuance since november 2008. still with me is gershon distenfeld, 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? gershon: i think the issuance has gone two places. one is -- 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 etf's, are some of these mutual 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%? remember, most bond trades, you get your money into or three days. a loan is 2, 3, 4 weeks. 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. what are your thoughts on that? luke: i have had a problem with that for a long time. this whole liquidity on an illiquid asset class looks really alluring. you think you can get in and get out. investors are little bit late to that trend. i agree with your other guests, 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 etf's and loans could get pretty

nasty. certainly one we are watching very carefully. jonathan: kathleen? kathleen: i could not agree more in terms of gappy. etf's are important, but you have foreign investors and the clo machine that has really been most of the appetite. when that changes and you see 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, that are looking for much bigger discount than that market has seen since 2008. jonathan: gershon? gershon: there is another factor at play. i have heard high-yield has done better than loans on the upside, just 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. the asset coverage is not as good as it used to be. we should expect more defaults 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 have not done a lot. they are looking at 2019, and 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 institutions are much, much heavier in bonds. you have to remember that we have been through a partial cycle already. are you in a late cycle? not in the commodity space. look what happened in the energy space and this trip in oil. very unlike 2015 and 2014 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.

a lot of people are pricing off of the federal reserve. but loans are priced off libor, and libor is still 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 long leverage loans. the flows showing up and the outflows in the last couple of weeks are basically the tourists. the people who do not know the asset class. 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 is going to step into support the market when it starts looking cheap? i think as you continue to -- as you say, the tourist flows, and the illiquid asset class, there is a risk. it will be lower before you see the institutions stepping in. as you said, the settlement is at issue, the legal issues about owning them 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 defined 2018 and much of what happened with loans with that last line. gershon: absolutely. you are technically correct that they price off libor. but in reality, they don't. libor has gone up 200 basis points in the last couple of

years, and loan has gone up over a hundred. when people are throwing so much money -- it will not happen on the downside. terrible convection. 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. up a single basis point on the 30-year. still ahead, the final spread, a really busy week ahead featuring central bank decisions from around the world. that conversation just around the corner. this is bloomberg "real yield." ♪

jonathan: i am jonathan ferro.

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. plus, we will keep an eye on u.s.-china trade talk and the potential other u.s. government shutdown. still with me, gershon distenfeld, kathleen gaffney, and luke hickmore. guys, a lot of people talking about liquidity, illiquidity, and making sure you have some liquidity. gershon, 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 in the previous segment about having continuous liquidity in etf. most investors should not have data liquidity. it actually hurts them. it is important in this part of the cycle, professional managers that want to move their portfolio around, if there is not proper liquidity, it will be costly.

jonathan: size matters here? kathleen: size definitely definitely matters here. being nimble is a great advantage. when you are large, it is difficult to make meaningful moves. jonathan: luke, 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 for sure, and size doesn't always cause you 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 have built up the amount of liquidity we have for sure. jonathan: talking to you guys, with the exception of leverage, i have to say 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 when 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 saying all the same things at the end of 2015. we are due for a recession and late in the credit cycle, and the fed will screw things up for us, etc., etc. 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 over the last six months. jonathan: kathleen? 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. we have seen these specific companies that have issues, and that is where the liquidity plays into long-term investors' hands. jonathan: luke? 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. in fact, you would have to look really hard for that to happen in history. yes, event risk will be important, but it is hard to play it from the long side. we would be cautious about that going into 2019 for sure. jonathan: a very sensible, constructive tone from all of you. i want to wrap this up in the rapidfire round. let's get to the first question as we look ahead to the federal reserve decision. can powell deliver a dovish surprise? gershon: no. kathleen: no. luke: not a surprise, no. jonathan: here is one for you, looking ahead to next year. can the ecb and mario draghi deliver a hike before he leaves? gershon: he could, but i will say maybe. kathleen: no. jonathan: luke? luke: he leaves in october, so definitely no. jonathan: i have an idea on where you all stand on the following question. i will ask it anyway.

the outperformance in 2019. does it come from leverage loans or high-yield through 2019? gershon: not even close, high yields. you could potentially have 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. although i am sure you would not appreciate that comment, any of you. 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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