jonathan: from new york city for our viewers worldwide, i am jonathan ferro. bloomberg "real yield" starts right now. ♪ jonathan: coming up, fueling global growth fears. the eurozone. trouble in paradise. leverage loan funds suffering the biggest outflows on record and the fed 2019 plans in the balance ahead of next week's decision. we begin with the big issue. what does the fed do when 2019 looks increasingly uncertain? >> pause. >> pause. >> the fed is going to pause. >> one hike being priced in.

>> pricing in one hike. >> there is a debate going on. >> two more. >> 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 they have obviously raised rates. it doesn't get as much airtime, but the $50 billion a month in the balance sheet is important to markets. >> neutral is not 2.5%. one person at the fed believes neutral is 2.5%. so we are not just below neutral, 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 their direction. at the moment, it is not clear. jonathan: joining me around the table here in new york city is gershon distenfeld, cohead of fixed income at alliancebernstein, kathleen gaffney of eaton vance, plus coming to us from edinburgh is luke hickmore of aberdeen. guys, great to have you.

is next week's decision really that much in the balance? kathleen: 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? gershon: 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 now we are going back to trend line? it is not either or. it is not that we're going to not hike at all or we will hike five times. the fed should not commit because it should be somewhat data dependent. jonathan: you are saying this is a market struggling to draw a distinction between a return to trend growth and a recession? gershon: the yield curve is telling you the fed has already gone too far. if you drop your regency bias 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. -- ticking up, you would say we should be above normal. jonathan: raising the real question of why this market cannot tolerate a 1% real rate. whenever we've reached that level, things start to fall out of bed. luke: 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 like an on/off fed, a start/stop fed. 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, yeah, 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 my response to it 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 cannot dovishly surprise, but you have got to maintain a dovish commentary, because they are transitioning away from the central bankers being in control. draghi just said his goodbye to bond buying. that means it is all in the politicians' 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: you mentioned the ecb. i think it is interesting to think about the european central bank can actually hike interest rates through 2019 20 federal reserve and money market people isn't doing much at all. week --joined last

>> even if the fed work to go two or three times, the fear was as the ecb was thinking it was going to be able to hike rates in the second half of 2019, it would be a difficult proposition given the fact the u.s. economy is slowing down. now there is a real chance that the fed might pause after the december meeting and that complicates policy for the ecb. jonathan: luke hickmore, if the 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 start taking 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. growth will be gone in europe. this doesn't feel like an environment where you get a rate hike at all next year. i actually don't think we get anything from the ecb until we are well in to 2020. jonathan: but gershon, you have got to talk about this relative

to where we are in the market and where we are in position. we have cleaned out a ton of shorts in the treasury market. on the 10-year yield right now, we are we are just south of 290. on the german 10 year, we are around 25 basis points. core government bonds are going into 2019 looking rich and pricing out a lot of inflation, a lot of rate action. does that mean we are primed for a move the other way? gershon: forecasting rates is very difficult, you know. jonathan: tactically speaking, looking at how we are setting up. gershon: i think the volatility will be a cause of what happens in the equity market. for a long time with nominal growth above 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. jonathan: kathleen? kathleen: i think what is weighing on the market is uncertainty and you could move into 2019 and 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 are you positioning for that? kathleen: i am total return. tips are relative. who wants to take a weaker return? either way, i would look away from the rates market for opportunities to increase returns. gershon: can i say something about draghi? he is a magician. jonathan: you think so? gershon: somehow he gets away with being able to give us basically no information. you are right, we are parsing every word that chairman powell says in the u.s., yet when it comes to draghi, we have no clue. 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? i have spoken to a few people who walked away yesterday quite worried. >> 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, though, that we have not talked about 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 are going to open up the stimulus's spigot again in a targeted way, and that will change everything for the global economy. jonathan: luke, do you see that happening? 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 to sort out next year, on the agenda, and it doesn't feel like an environment where they really need to tighten up. we need another trail for italy, or you could run into a credit

crunch in the next year or so, 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: guys, you are going to stick with me. gershon distenfeld from alliancebernstein, kathleen gaffney of eaton vance, and luke hickmore of aberdeen. the drought in high yield issuance continues, reaching a level we haven't seen in a decade. that conversation coming up. this is bloomberg "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. -- issuer in the abs market. 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.

kathleen, 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. jonathan: gershon? gershon: i think the issuance has gone two places. one is coming anyone that is new, 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: and we are seeing big outflows. let's put them 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 fund issues from some of the mutual funds. 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 daily liquidity on an illiquid asset class looks really alluring. you think you can get in and get out. most of the time you can. 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. four years i have heard high-yield has done better than loans on the upside, just wait until the downside, they are senior secured. what we are seeing now is, 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. -- trick down in oil. a 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. but, it is not expected to move that much higher. so 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 -- side and get 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. the institutional is staying calm. 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, -- issued 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. didn't they? gershon: absolutely. you are technically correct that they price off libor. but in reality, they don't. libor has gone up 200 basis

points over the past couple of years, and loan has gone up over a hundred. when people are throwing so much money, we made that point many times 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." time now for the final spread. in the next week, 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 for a partial 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. -- etf versus daily 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

very difficult or very costly. jonathan: size matters here? kathleen: size definitely definitely matters here. being nimble is a great advantage. when you are large, it is very difficult to make meaningful moves. luke, yourocate 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?

what do you say about next year? 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 the kinds of 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 the ge's, 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 am going to 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. jonathan: kathleen? kathleen: high-yield. jonathan: luke? 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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