♪ jon: from new york city for our viewers worldwide, bloomberg "real yield" starts right now. ♪ jon: coming up, from hawkish to dovish and then totally confused. wall street grappling with said communication. the latest market worries, shutdown politics weighing on sentiment. plus, volatility. we will begin with a big issue, a market gripped by federal reserve confusion. >> chairman pals message yesterday was so prophetic, it was taken badly by the market. >> it was a dovish hike. >> not as dovish as the market

had discounted 10 minutes ago. >> that is a fairly dovish signal from the fed. >> three months ago, he was quite hawkish, and then became more dovish. yesterday he was both. >> i didn't interpret the statement nearly as hawkish as market participants seemed to it >> dovish on interest rates but hawkish on the balance sheets. >> the fed seems quite bullish on growth. >> he did not deliver an early christmas present. >> but became more dovish at the same time. >> to some extent, the point seems to be lost on the markets. >> to underscore the dovishness, the market reaction, it is going to try to be more dovish. >> in high uncertainty, the rule should be, we pause. all he had to do was say that and markets would be at ease. jon: joining me around the table is george gonclaves, scott kimball, and brian rehling.

brian, i want to begin with you. if the spread of interpretations are that wide there is something , wrong with the message. brian: yeah, it is really difficult for the fed because we are approaching the end of their easing cycle. the neutral rate is a bit of a moving target, there is not consensus exactly where that is that, so it is going to be more difficult for the fed to clearly communicate exactly when and how quickly they are going to end this rate hike cycle. jon: do you understand the reaction function? >> i would be hard-pressed to tell you that any of us really do. you used the word grappling to start the show and that is exactly what we are doing. when we look at what the fed gave us, the moving target of the neutral rate has clearly perplexed and caused a large dispersion in what investors expectations are. we were in the start of the year with a quote from chairman foul -- chairman powell saying we are away from neutral to now saying, we are at the lower end of the neutral range. >> there is clearly confusion. chair powell left us with a

confusing message, but i don't think they know how to the markets. jon: let's be more specific. i do not think that chair powell knows how to settle market nerves. why the chairman struggling to connect with this market? >> they are going back to their comfort zone of understanding models and trying to figure out what is the neutral rate, and it will be challenging for them. i think you got a little bit of it today with williams, throwing a bone at the balance sheet. but i think there is no consensus and that is hard for the chair to deliver a strong message. jon: the premise of this conversation is that they need to settle the market down. do they? >> i do not think the fed is as concerned about the markets as the market think they ought to be. i think the fed is going to look at the data and it is slow to come in and slow to change and there is a risk the fed is

behind the curve in the markets are looking forward. i think that is a big risk given that the fed is focused on the data. jon: what do you think the biggest issue is in terms of policy, the spread between the markets on rates and the federal reserve or the spread between the federal reserve and a balance sheet that think should the on autopilot, and many market participants who think it should not be? brian: the rate policy is by far the most important. the balance sheet policy -- i know the market is fixated on that recently, but it has not been a big focus for a while. if you look at the balance sheet, it is still really, really big. we have only just seen a little bit of decrease if you look at the big picture. i'm not sure that $50 billion a month of rolloff is a big deal. i think the rate policy is a far bigger deal. jon: if it even gets to the $50 billion of max rolloff good -- rolloff. this raises the question about the rates. are we arguing over 25 basis

points, because that is the spread now next year? >> if we take the fed's forecast, they are telling you to the point on rate policy that they are going to be done on whatever this policy is in whatever term rates will be in 2019. that point, it will translate to the broader view of the balance sheet. george: they have to be careful not to over read things either. we have had a big market move, we have had bad positioning, and to overdo it, the fed has to be careful. i think they did the right thing. jon: are they going to be able to answer simple questions? chairman powell was asked the twice, inflation is going to undershoot again, what are you raising interest rates? he could not answer the question, george. it was a nightmare performance in the news conference. the was not just average, it was terrible. everything was lined up in the statement. you could've crafted a better answer into to that question the

-- that question them the chairman of the federal reserve can. george: they are at the point where the outlook gets a little bit fuzzy. it is toward the end. no one said it was going to be easy. they are the only central bank that has raised rates. they have got pretty far and i think we need to give them credit at this point. jon: are you ready to price a policy mistake and what does it mean to you? george: the policy mistake is more embedded in risk assets than the rates market. but the rates market has had a big adjustment. to go much further here, the curve starts to massively invert and that would be a signal of an international policy struggle. jon: do you anticipate that? scott: to use the word grappling to your point on the inflation, what the fed is grappling with is this is one of the most prolonged tightening cycles they have gone through. the fed loves their models. the error on those models is getting long. everything of their models says the inflation output numbers should be higher than it is. jon: this was the federal reserve under chairman powell that should have been emphasized

-- should have been deemphasizing the models. why are the models important again? i love the idea that they are data dependent but no one understands the reaction function. it is totally useless if you don't understand the reaction function. when are they going to do a better job explaining the reaction function? brian: i am not sure they are. i think they are focused on the models, and i think they are deliberate and slow-moving body, and i do not think they are going to react to the markets like the markets would like to see the fed react. jon: after the performance of the federal reserve the last couple of weeks, are you more willing to add duration than you were before? brian: no, not yet. i still think it is still some more to these -- to this recovery. i think the yield curve, even though it is quite flat, it tells us that there is more growth to the recovery.

i think the risk off move is overdone. i would be looking for opportunities to extend duration, but i do not think that now is the right time with rates down when they are. jon: george, what about you? big bid coming into tens, 30's, that massive short on the long end. is now the time to add duration? or did we miss the pocket? george: you missed the pocket of opportunity, and it has to be real yield. that's what is going to really cap the rule level and the rise of rates next year. scott: we agree. our view is the rates rally has been overcooked. the market expectation of the reaction function often needs to be realigned. the fed going from three hikes to two is a dovish outcome for reserve standards. jon: you're not going to go from three to one without the economy totally cratering. i think maybe the base case for some people is over a number of months and meetings, we may well reconcile down to where the

market is now. with me is george gonclaves, scott kimball, and brian rehling. coming up, the auction block. revealing the year in issuance. what a year it has been. this is "bloomberg really yield." ♪

♪ jon: i am jonathan ferro. this is bloomberg "real yield." i want to head to the auction block and take a look at the numbers for issuance in 2018. a monster year. we start with the u.s. treasury. year, $1.3ndar trillion raised in net new cash.

over in corporate, high-yield issuance drying up completely. and massive outflows and high-yield funds. in leverage loans, a surge of roughly $800 billion in new loans issued, even as the price index tumbled to close the year. still with me, george gonclaves, scott kimball, brian rehling. george, let's start with where the issuance has come from and what it has meant to the broader market. what does it mean for crowding out other asset classes? george: you took the words right out of my mouth. it has been a crowding out. there is more to come next year. it's not going to end. 2019, a similar story. lower corporate issuance, largely because there is less rollovers, but equal rollovers but less overall issuance and the treasury market is not picking up a lot of that space. jon: we had em central bank governors complaining about the

prospect in the spring, of that extra issuance sucking up dollar liquidity, do you still see that being a big problem? brian: sure, it is going to continue to grow. the treasury has to fund to meet the deficit, so the crowding out is a real issue. it is not going to manifest itself in terms of higher treasury yields, but it is going to manifest itself in terms of less liquidity elsewhere in the bond market. scott: i have to agree with that. the data behind treasury supply, what that means for u.s. nominal treasury rates is murky, but it is occupying space that could otherwise be making its way into other risk assets. jon: at the turn of the year, we had all of the conditions to fuel demand for leverage loans, and we had the supply that came with it. we end the year with a lot of people in fixed income questioning that universe. brian, big outflows from etf's that track leverage loans, the cash is flowing out. typically, when we talk about flows, we talk about them confirming a trend.

is there any signal in this? brian: we have seen several periods where high-yield spreads have lightened out. throughout this cycle. i think the question is, does this spread remain in the energy names and lower credit quality, we are seeing retail move out of a lot of these yielding assets that they had purchased earlier in the cycle when rates were much lower. the question is whether this is the beginning of the end or this is just another event in a series that have impacted credit this cycle. i am not sure we know the in syria. scott: there is a confluence of events. if you think about the your asset allocation perspective, a lot of money came into leverage loans, part of it to be defensive on interest rates and using it as a surrogate for shortening duration overall. if you look at the big perspective of what is going on

in the market, with the rise in volatility, people forget about junk stocks and bonds and cash. it just becomes, do i want cash or risk? the event is everything that is risk is going to be equally affected, but those who have seen the unusual flows down the stretch are going to be outsized. jon: the turn of the year when pretty much everyone hated cash, it was the moment we are about to get the real rate of change. cash was going to start increasingly returning more and more. what's interesting, at the end of the year, people are starting to fall in love with cash at a time that we are talking about the federal reserve pausing and the rate of return on cash ultimately leveling out. george: that's a good point. perhaps that is also motivating some of the outflows, too. any floating rate products, you would not get much further yield pickup. jon: you will get a continual adjustment if you believe the rate of return on cash of going to carry on increasing. at the moment, i think we can

probably paint a picture where we say the rate of return on cash is going to stabilize through 2019. my question essentially is, whether we have seen that adjustment now in the back end of this year, when flows have picked up aggressively enough to adjust for the fact that cash returns a little bit more. is this still going to be a significant story next year? brian: that is a good question. i think you are right, the cash returns are going to start to level out, so that is part of it. but i do not think you can overlook the massive risk off move we have seen from investors in general and to the extent that this was a product that they were really piling into earlier this year, they were over allocated and needing to adjust that. jon: we were talking about some of the technical issues and high-yield and leveraged loans. let's talk about the fundamentals. what to the earnings look like? trendsople say those look positive through 2019.

brian: i'm sure they look good through 2019. so i do not think we will see significant falloff for the fundamentals. the question is markets discount forward-looking so are we going , to see a falloff in fundamentals and 2020 and beyond? our investors are preparing. i think the market is overshooting. they were a little too optimistic and i think they have moved to being too pessimistic. jon: we have the overshoot, and the conversation i keep having is whether the overshoot becomes reality, we get that timing and financial conditions that it mean something to the fundamentals of the economy. the ability of corporate to come to the market and raise cash. does perception become reality? >> the economy still looks pretty good. wage data continues to trend positively. it's tough to take a read from

december and extrapolate this into a 2019 your -- your long event. george: the timing happened at the end of the year. returns are down and assets are under pressure, but in the grand scheme of things, these are minor corrections versus history. we turn the counter, cash flows coming in, seasonal behaviors to market such as hopefully stabilize things. guests are sticking with me. let's check on where markets have been the last full trading week of 2018. yields lower on a two-year by about nine basis points. duration kicking in, 10 basis points lower. up, theon a 30 coming final spread, looking ahead to the first week of 2019 including payroll, and you will hear from chairman powell. what a way to start the new year. this is bloomberg "real yield." ♪

♪ i'm jonathan ferro, this is bloomberg "real yield," time for the final spread. looking to the first week of 2019. half of the people will be ringing in the new year, and the new congress could define the are politically for the united states. we will also from jay powell, and get the first payrolls report. to start the year and to close out 2018 with a look back as well. are still with me. brian, lisa and i were talking conviction trades, and the lack of conviction that many people have. typically we going to any year with a big consensus trade we can all get our hands around,

but i don't see that this year, do you? brian: not yet, but january is usually a positive month. after the beating markets have taken in december, hopefully we can find some footing and start to change the sentiment a little bit. scott: i think i degree. i think that december's can cause you to miss an opportunity in january. if you look at the fixed income marketplace, credit spreads and durations of traded punches, but there are opportunities to investing credit, and the high-yield indexes pushing 8%. there are reasons to be constructive. peoplegood point, many have complained about the federal reserve, and i've complained about the communication. many investors have sent me messages saying, thing goodness, i've been waiting a couple of years for this, high yield starts looking like high-yield, who would've thought it? there's a lot of opportunity for some people. brian: no question, even in short-term and high-quality maturities, you see yields available to investors we

haven't seen in over a decade. definitely a bit more of a buyers market in fixed income them for quite a while. thatsome people look at chart and say, i looked at 2016 and i know how that plays out. can you get that kind of turn again for the economy, where you get the kind of reaction we got in .15 and 2016 from central banks? can we have that next year? george: not early on. decent, you will come in with some trepidation and eventually we get our footing, and we see capital put the work. i agree with the other guests, but i think it will create a situation where the fed wants to hike in march. once we get that hike, we will do this all over again, and what is going to challenge risk assets is risk will go up again. they will go up again over the course of 2019, at least until the middle of the year. they may will see if we can handle higher rates again. i think -- we talked about supply, and again, there is peak

bearishness overall. global rates are also floored. ofcould see a natural kind move higher in rates as all of the supply comes in from global markets. jon: we had stripped back inflation expectations, strip back rate sector expectations as well. do you get the sense we might've gone too far? given the positioning on the long end, we had cleaned out the shorts. is there an opportunity for you, brian? brian: absolutely a think we've got too far. the tricky thing about markets, when you think they've gone too far, they often go further. i'm not sure the pain for risk assets is over. we might see rates go a little lower. i definitely think it's an overshoot, expectations falling like they have an overshoot, and i would expect reversal into next year. scott: i agree on the rate. i think rates have been overcooked, and our strategy has been to continue to look through it at the data underneath it.

some firmness get out of the consumer portions of the economy, there will be room for rates to matriculate higher. jon: let's get to the rapidfire round, short answers short questions. i've been asking if you investors us through the week as we close out the year. higher or lower by year-end on the u.s. 10 year yield through 2019? higher or lower than where we are at the time we recorded this program? george: we haven't had a full round trip where we are now. scott: higher. brian: higher. does the curve invert before the federal reserve hikes again, assuming none of us have any idea when they will hike again? do you get curve inversion? were about 10 basis points away. george: only if we see brexit have a hard brexit. scott: with what is going on in

washington, tempting, but no. brian: i don't think so. jon: i did nothing brexit would be part of the story. george: it's about u.k. gilt. jon: next your, outperformance and leveraged loans or u.s. high-yield? george: high-yield. scott: high-yield. brian: high-yield. jon: great to catch up with you all to end the year. from new york, that does it for me. we will see you next friday at 1:00 p.m. new york time, 6:00 p.m. london, with a special yield." bloomberg "real ♪

yousef: the major stories driving headlines this week. ministerbia's finance says the kingdom is looking at billions of dollars in bonds next year. fierce rathole markets. ears reptile markets. years in doha to end the at the most expensive level in years. fears rattle markets.