jon: from new york for our viewers worldwide, a special edition of bloomberg "real yield" starts right now. jonathan: coming up, markets drawing attention as the fed keeps the balance sheet on autopilot. doubts increasing and whether mario draghi can hike rates before his term ends. and a monster year for leverage loans ending with a serious concerns. we start with the big issue. going at the 2019 with one certainty. >> there is significant uncertainty about the path and ultimate destination. >> uncertainty is playing into this. >> raising of uncertainty.

>> uncertainty about the global growth. >> markets have gotten so spoon-fed for so long that any big change in anything upsets them. >> the market is not high on the fed's list of things to pay attention to. >> not going normal on the yield curve because the yield curve is upward sloping like 90% of the time. as the curve keeps flattening, it tells us that monetary policy is being too restrictive. >> markets got very used to this ever-increasing amount or steady flow of increasing amounts of liquidity. liquidity has been drawing out. >> i would love the balance sheet acknowledgment to be on the list, but that seems hell-bent for what we are going to keep doing what we have been doing. >> we know the economy may not be as kind to our forecast next year. jonathan: joining me around the table is noelle coram, ira jersey, and tony rodriguez. let's begin with you.

year end forecasts are typically pretty useless for many people. [laughter] jonathan: this time around, i cannot think of a year with there is so much uncertainty going at the 2019. noelle: right. that is the certainty, the amount of uncertainty. we are thinking about it in three main macro buckets. each bucket has -- they work together and drive asset prices. growth which we see as moderating but still solid, inflation which is going to be noisy as tariffs are noisy, and financial conditions are policy which in q4 of 2018 was the primary driver of markets. that's why you saw some of that underperformance in credit. looking forward, we do expect that to continue and we expect the fed to be battling between a solid growth picture and tightening financial conditions, so we do expect to see some tightening into q1 and q2 of

next year and that is why we stayed defensive. ira: the uncertainty next year is going to come around the fed mostly. regardless of what happens with the economy in the first quarter, the question is the fed going to go two times next year or not? we are mincing this because realistically as 25 basis points in overnight rates enough to derail the economy -- the answer is probably not. it has to do with confidence in the board room and animal spirits and whether or not people think the fed is going to make a policy mistake. jonathan: it is not the first time we have had tension between the markets and the federal reserve, but i am trying to get my head around whether the tension is around rates or the balance sheet. where is it for you? tony: a little of both. the fed has been chasing the market, and we get seen them reduce their dots on multiple occasions. i think that is what we are going to see in 2019. the uncertainty is how quickly

will kind in the first quarter or delay that. they are being dogmatic around the balance sheet so the market knows the liquidity in the balance sheet reduction taking out of the market has increased volatility. if the fed were to show some flexibility on the balance sheet, which would make sense for them to do, that would help quite a bit in terms of reducing some of the volatility in the market. you are right, it is double-barreled on the rate and balance sheet, and i think you will see the fed continue to play catch-up with the market as they reduce their currently projected level of rate hikes and maybe modify the autopilot that the balance sheet seems to be on. jonathan: just a pickup the comments, i don't want to diminish the importance of the balance sheet.

what is interesting going into the most recent federal reserve meeting, that was not the focus. coming out, it was. why? noelle: the fed has shown us that the balance sheet is not going to be a 2019 story. it has been a focus because the financial conditions tightening, though a lot of the market thinks that is liquidity issue, but in fact, global financial conditions have been tightening and that has been hitting credit from a global perspective. and we have seen financial conditions tighten from the fed. ira: i am passionate about this because firstly, we make too big of a deal of balance sheet unwind. the balance sheet unwind peaks in the middle of 2019 and then gets smaller. automatically, we will have less balance sheet unwind in the second half of 2019 than we have had the last six months. that is just mathematics. i think secondly, the federal reserve will most likely stop hiking before it ends its balance sheet reduction. at worst, they will do both at

the same time because financial conditions have gotten tight. the one thing that the balance sheet reduction has done, i think this is what people talk about liquidity, is that when you look at effective money growth, our measure of effective money growth that bloomberg intelligence, it has stopped. it was 5% for the last few years and this year, less than 2%. it is slowing down so much and that has an effect on growth and certainly inflation. jonathan: you brought up the prospect of a policy error. tony, i want to ask you the question, whether this market is starting to price a policy error and what that actually looks like. tony: pricing in a policy error, because the fed chasing the market as they reduce their dots and terminal rate is really the idea that if they stick to their plan, the market believes that is a policy error. if they go with two tightening next year, i think that would be a policy error.

i think they will come forward next year first in speeches and been in meetings, and further reduce their projected path, and i expect next year, most you would see is one tightening. they are data dependent but having trouble having their communication keep up without -- with how data dependent they are going to have to be. the risk of policy error is high if they stick to their plan. you have policy errors that can hit the market on the trade side and in europe, whether it is brexit, etc. the policy risk is high, because we agree that we will see a moderation in 2019, but that may be more severe than we expect. the risk has to be priced in. when you combine those, volatile markets, a repricing of risk, and cautious investors.

ira: the fact is the fed is chasing the market. the market was priced for one hike when they said they were going to do three. now they are priced for less than one hike even though the december dock said they were going to do two. that is something that is likely to continue. jon: it seems to me that the federal reserve has a massive communication problem. you cannot have a chairman and a perception of the chairman that is very, very hawkish and than a month later, very, very dovish, and than a month later, terribly confused. those things have stacked up in about two months. for me, when that happens, it is not the person on the receiving end of the messaging that is the problem, it is the person delivering the message. have they got a communication problem? noelle: they have been trying to stick to this data dependence. if you think about it, a lot of the data has not deteriorated in a significant way. that is why they seem a little bit confused because financial conditions could start to feed in to the data.

but they have not seen that and -- seen that in a significant way and that is why they are not backing down and we do not expect them to in the near term. we are only calling for two hikes in the next year. companies are in a spot to absorb those two hikes. the market is pricing in a little bit of a policy error, but where growth is and companies are fundamentally, if it happens gradually, we can withstand that. jonathan: the spread between the market and the fed is not that big. what i thought was the biggest mistake in the news conference, and i would love your insight, two questions back-to-back -- inflation is going to undershoot your target. why are you raising interest rates? and he could not answer the question properly. why not? tony: that is what i was going to bring up. that is a great point. that is part of the confusion in the market. when you reduce your growth projection, which they did, and

your inflation projection, that seems inconsistent with the market with continuing on the path of tightening at the meeting, talking about the balance sheet being on autopilot, and still talking about two tightening's next year. that is where the fed needs to do a better job of communicating to the market. the reality is that communication will be that they will not to be as aggressive as the current path dictates. as we see that, we will allow in 2019 to help the markets to stabilize. but for now with poor liquidity conditions, equity markets really suffering in the fourth quarter, you will see in the beginning of 2019 still the uncertainty in the market and the volatility. so the situation that we think, while it is likely to take place given our outlook for a

relatively reasonable growth picture, slower but not recession, i think it is going to take a few months from the market to digest. jonathan: you are going to be sticking with me, tony rodriguez, noelle corum, and ira jersery. -- ira jersey. coming up, we review the year that was in supply. this is bloomberg "real yield." ♪

jonathan: i am jonathan ferro and this is bloomberg "real yield." we want to head to the auction block and take a look at the issuance numbers for the year that was. 2018. we start with the u.s. treasury. in the calendar year, $1.3

trillion in net new cash. this number dwarfing previous years. over in corporate's, high yield issuance hit a drought to close out the year. year to date levels slowed to levels we have not seen since 2008, together with massive outflows. leverage loans, there was a surge, roughly $800 billion in new loans issued, this came even as the price index tumbled to close out the year. still with us is noelle corum, tony rodriguez, and ira jersery. -- and ira jersey. i've asked many people would 2019 will bring for credit, and a have said, show me q1 and i will show you the year. how tough is q1 going to be? noelle: it is going to be extremely tough because credit is going to be stuck between the battle of growth and the global financial conditions in general because you have the fed that is just watching the data and the growth data continues to look solid. credit is going to be hit from both sides because of that, so we think it is going to be tough

but we do expect the fed to respond accordingly. they have been very open and willing to respond if it sees through to the data, and i think that is what they are waiting for. that is when we expect credit to be well-positioned, because corporates are fundamentally solid. defaults are low. they are in a position where they can stop their share buybacks and pay down debt. as long as things are gradual and we do not see a massive slowdown in growth, we think they'll be able to absorb both the fed and any further growth -- any slower growth trajectory. jon: the disconnect, the decoupling we have with the markets and the real economy in the united states is one of the perception can become real. the fact is, whether they should be or should not be, spreads are now two years wide. for any issuer in that space, when they come back to the

market, they will be paying much higher interest rates. can the perception become real? can the technicals become fundamental? tony: you are absolutely right. they can. we do not think that they reach that level so i tend to agree with noelle. but at some point, there is going to be a pretty good entry point because ultimately, the fundamentals, we speak despite the liquidity condition of has raised financial cost, that will clear up over the course of two months of 2019. we think it certainly can, but i do not think you will see that happen this cycle. we are more likely to see an extension of the credit cycle as liquidity conditions stabilize and improve in the first quarter. ira: there are two interesting things here. with this selloff, you see a bigger and much wider dispersion

of credits. there have been some credits that have underperformed and others that did not do badly. the market is discerning a little bit. i think secondly, there is a potential systemic problem where it corporations decide, the spreads, we do not want to issue bonds, they might not. but because of the rally you have had an rates in yields, for investment grade firms, even triple day -- triple d, yield today is lower than it was in november. funding is not particularly expensive for a lot of these companies. jonathan: i want to talk about leverage loans with you. it is a popular pain for a lot of people and a vicious cycle. the biggest demand comes from clo's and the whole thing starts doing this. how do you break the cycle in leverage loans? noelle: we think q1 is going to be tougher credit in general,

leverage loans included. but looking later into the year, in 2019, the cycle needs to be broken by financial condition stabilizing. growth is not that bad. europe in china growth in general will be supported by stabilization. so we really need the fed to step in and stick to their word and respond to the data as it starts to turn down. jon: but we talking about the fundamentals. tony, i want to talk about the liquidity and potential for a real liquidity mismatch. incrementally and increasingly, the marginal buyer in leverage loans this year was retail. we have seen retail start to head to the exits in a big way in etfs. are we set up for an accident in this space?

tony: i certainly think that does have the ingredients for an accident, but at the same time, i think of the market has some mechanisms to avoid that, meeting some of those bars can move to the high-yield markets, the banks directly for the lending, and the repricing we have seen where you -- where loans were yielding less than the market, that has collapsed to levels we have not seen since 2007, 30, 40, 50 basis points. that repricing makes the clo more attractive to the investor. i think you can see a recovery in the clo market. because of the repricing change in the relative attractiveness of it. now it is very competitive with the high-yield market and other yield segments. jonathan: guys, you going to stick with me. tony rodriguez, noelle corum, and ira jersery. coming up, the final spread. the week ahead to start the year, featuring comments from jay powell and the first jobs report of 2019. this is bloomberg "real yield." ♪

jonathan: i am jonathan ferro. this is bloomberg "real yield." it is time now for the final spread. coming up over the next week, after people are done ringing in the new year, the opening day of congress, jay powell will speak. the first u.s. jobs report of 2019. still with us, noelle corum, ira jersery, and tony rodriguez. bloombergsey from intelligence and tony rodriguez. to start off the week of 2019 with jay powell coming up, the most interesting central bank will not be the fed, but the ecb. how on earth does president draghi plan to raise interest rates before he heads to the exit? tony: you are right. he cannot do that. right now, the economy there cannot sustain higher rates. he is going to have a

communication issue as well to get the market to be comfortable with what the ecb is going to do. and the ecb is going to have to display patience given what has happened in growth in germany and globally. jon: the best measure of the european economy is the german ten-year. to think about the confidence that we had coming into 2018, that it would end the year lower than when it started. ira: that shocked a lot of people. one of the challenges for europe is how do they get out of this growth malaise? what is the way they get around it? at this point, there is little that monetary policy is going to be able to do.

they have literally negative interest rates and that does not seem to have done the trick to get lift off for the economy. you have had little bumps. things have not deteriorated a lot, but it is very unsatisfying growth. jonathan: in the spring when everybody started coming on the program and saying that the risk in places like emerging markets was idiosyncratic, and then i got sick of that word within a couple of weeks. the surge of idiosyncratic risks very quickly became a pitch for systemic risks for emerging markets. that was the tell, it was the leading indicator for the global marketplace, the tension in emerging markets. how does that play out? noelle: these two points are related because the european domestic market has been the place. employment is stronger, wages are building, internally, dealing with uncertainties. we think the next year, they are going to focus more on fiscal policy and that is going to stabilize growth in china, thus stabilizing growth in em and

europe. at least from the external side. jon: can we get that turnaround in em in the way that noelle thinks we can? tony: i think it is possible because we will hopefully see stabilization in energy prices and global growth. that will help a lot. the fed backing off will take a little bit of steam out of the dollar, which is one of the larger headwinds in emerging markets. if we can get the dollar to stabilize and the growth picture to not be recessionary, but just healthy but lower growth, those are the ingredients for emerging markets to stabilize. jonathan: looking ahead the 2019, the final rapidfire round of 2018. you know how this works. quick questions, quick answers. let's start with higher or lower by year-end 2019, the u.s. 10-year yield. noelle: slightly higher. ira: lower. tony: slightly higher. jonathan: does the curve invert

before the fed hikes again? yes or no? noelle: no. ira: yeah. tony: unlikely. jonathan: looking ahead to next year, outperformance in leverage loans for u.s. high yield. loans or high-yield? noelle: loans. ira: high-yield. tony: loans. jonathan: noelle corum, ira jersey, and tony rodriguez. it has been great to have you with us and great to have you with us all year. looking ahead to next year, we will see you next friday, 1:00 p.m. new york time. happy new year. ♪

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carol: welcome to "bloomberg businessweek." i am carol massar. jason: and i am jason kelly. we're here at bloomberg's global headquarters in new york. carol: we zero in on the future with conversations from the year ahead summit. jason: some of the most influential figures in business and politics spoke at this event.