jonathan: from new york city for our viewers worldwide, i'm jonathan ferro. a special edition of "bloomberg real yield" starts right now. coming up, markets drawing attention as the fed keeps the balance sheet reduction on autopilot. doubts increasing on whether president draghi can hike rates before his term ends. and a monster year for leverage loans ending with some serious concerns. we start with the big issue, going into 2019 with one certainty. >> there is significant uncertainty about the path and ultimate destination. >> uncertainty is playing into this in a big way. >> 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 very high on the fed's list of things to pay attention to. >> certainly not going normal on the yield curve, because the yield curve is upward sloping like 90% of the time. as the curve keeps flattening on us, it is telling 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. and liquidity has been drawing out. >> i would love the balance sheet, at least an acknowledgment of it, 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, portfolio manager at invesco fixed income, alongside ira jersey, chief u.s. interest rate strategist at bloomberg intelligence, plus coming to us from minneapolis is tony rodriguez, chief taxable

fixed income strategist at nuveen asset management. noelle, 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, for a long, long time, where there is so much uncertainty going into 2019. noelle: right. that is the certainty, the amount of uncertainty. we are thinking about it in three main macro buckets. each of those macro buckets has -- they work together and drive asset prices. so growth, which we see as moderating but still solid, inflation, which is going to be noisy as tariffs are noisy, and then financial conditions or policy, which in q4 of 2018 was the primary driver of markets. and that's why you saw some of that underperformance in credit. but 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 a little bit of q2 of next year and that is why we stayed defensive on credit. 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 actually going to go two times next year or not? and we are mincing this because realistically as 25 basis points in overnight rates enough to derail the economy -- the answer is probably not. but 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. i think that is where a lot of the uncertainty is coming from. 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 predominantly over rates or the balance sheet. where is it for you? tony: i think it is actually a little bit of those, because the fed is chasing the market. -- the fed has been chafing the

market. we have 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 they will do that, whether they will tighten in the first quarter or delay that. i think they are being a little dogmatic around the balance sheet, so the market knows the liquidity in the balance sheet reduction is taking out of the market has been a negative and 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. so i think 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 to pick up the comments from tony, i don't want to diminish the importance of the balance sheet. many guests have brought it up on this show, many times throughout the year. what is interesting going into the most recent federal reserve meeting, that was not the focus. but coming out of it, it very

much was. why? noelle: the fed has shown us that the balance sheet is not going to be a 2019 story. and 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 tightenings next year and the balance sheet is completely on autopilot, i

think that would be a policy error. i think they will come forward next year first in speeches and then in meetings, and further reduce their projected path, and i expect next year, most you would see is one tightening. you may see none depending on what the data actually tells us. so i think they are data dependent but they are having trouble having their communication keep up 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. so that risk has to be priced in. when you combine those, volatile markets, a repricing of risk, and i think you get cautious

investors. ira: the fact is the fed is chasing the market. the market was always 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 dots said they were going to do two. that is something that is likely to continue in 2019, that the fed chases the market down. jonathan: 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. i mean, those three things have stacked up in the space of around 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. and 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

into the data. but they have not seen that in a significant way and that is why they are not backing down and we do not expect them to, at least in the near term. we are only calling for two hikes in the next year. i think companies are in a decent spot to absorb those two hikes. i think the market is pricing in a little bit of a policy error, but where growth is and companies are fundamentally, if it happens gradually enough, i think we can withstand that. jonathan: the spread between the market and the median dot 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 for another year. you are forecasting that. why are you raising interest rates? and he could not answer the question properly. why not, tony? tony: that is exactly what i was going to bring up jonathan, and that is a great point. that is part of the confusion in the market.

when you reduce your growth projection, which they did, and you reduce your inflation projection -- not only reduced it, but at a level that is below your target, it is close to your target, but 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 tightenings next year when you are forecasting 1.9% inflation into 2020. 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 be as aggressive as the current path dictates. as we see that, we will allow in 2019, that will help the markets stabilize. but for now with poor liquidity conditions, equity markets that are really suffering quite a bit in the fourth quarter, you are going to see in the beginning of 2019 still the uncertainty in the market and that volatility. so the stabilization, we think, while it is likely to take place

given our outlook for a relatively reasonable growth picture, slower but still not recession, i think it is going to take a few months for the markets to digest that. jonathan: hey guys, you are going to be sticking with me, tony rodriguez from nuveen asset management, noelle corum from invesco fixed income, and ira jersey from bloomberg intelligence. coming up on the program, the auction block. we review the year that was in supply. this is "bloomberg real yield." ♪

jonathan: i am jonathan ferro, this is "bloomberg real yield." we want to head to the auction block now and take a look at the

issuance numbers for the year that was. the year of 2018. first, we start with the u.s. treasury. in the calendar year, there has been $1.3 trillion raised in net new cash. this number dwarfing previous years. over in corporates, high yield issuance hit a drought to close out the year. year-to-date sales slowed to levels we have not seen since 2008, together with massive outflows in high-yield funds. in leverage loans, there was a surge, roughly $800 billion in new loans were issued, this came even as the price index tumbled to close out the year. still with us to discuss is noelle corum from invesco fixed income, ira jersey from bloomberg intelligence, and tony rodriguez from nuveen asset management. noelle, i've asked many people would 2019 will bring for credit, and they 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 or the fed, 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. and 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. and that is when we expect credit to be well-positioned, because corporates are fundamentally solid. you know, defaults are low. they are in a position where they can stop their share buybacks and pay down debt. and so as long as these things are gradual and we do not see a massive slowdown in growth, we think that they'll be able to absorb both the fed and any slower growth trajectory. jonathan: tony, this is an important point of tension for me. 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 at two-year wides.

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 certainly can. we do not think that they reach that level so i tend to agree with noelle that it might be a pretty difficult first quarter, 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 costs and limited access to financing, that will clear up over the course of two months of 2019. so we think it certainly can, to your point, jonathan, 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. one, with this selloff you have seen in the past couple of months, particularly in the investment-grade market, you have seen a bigger and much wider dispersion of credits.

there have been some credits that have underperformed and others that have not done that badly, right? so the market is discerning a little bit. i think secondly, there is a potential systemic problem where if corporations decide that hey, at these 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 b's, yield today is lower than it was in november. funding is not particularly expensive for a lot of these companies. jonathan: but the funding market has tightened up. look at leverage loans. and 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. clo's get hit and the whole thing starts doing this. how do you break the cycle in leverage loans? noelle: we think q1 is going to be tough for credit in general, leverage loans included. but looking later into the year,

in 2019, the cycle needs to be broken by financial conditions stabilizing. because growth is not that bad. europe and china, growth in general will be supported by stabilization. so we really need the fed to step in here and kind of stick to their word and respond to the data as it starts to turn down. jonathan: but we are talking about the fundamentals. tony, i want to talk about the liquidity and potential for a real liquidity mismatch. incrementally, increasingly, the marginal buyer in leverage loans this year in 2018 was retail. we have seen retail start to head to the exits in a big way in etf's. 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 the market has some mechanisms to avoid that, meaning some of those bars can move to the high-yield markets, the banks directly for the lending, and the repricing we have seen 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, of course, makes the clo more attractive to the investor. so i think you can see a recovery in the clo market. because of the repricing, change in the relative attractiveness of it so now it is very competitive with the high-yield market and other yield segments. jonathan: guys, you going to stick with me. tony rodriguez from nuveen asset management, noelle corum from invesco fixed income, and ira jersey from bloomberg intelligence. coming up on the program, the final spread. the week ahead to start the year, featuring comments from jay powell and the first jobs report of 2019. that's next. 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 around the world are done ringing in the new year, we have the opening day for the 116th congress, and jay powell will speak, and the first u.s. jobs report of 2019. still with us, noelle corum from invesco fixed income, ira jersey from bloomberg intelligence, and tony rodriguez from nuveen asset management. tony, to start off the week for 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 look to raise interest rates before he heads to the exit? tony: you are right. he cannot do that. right now, the economy there certainly can't sustain higher rates, in my opinion. so 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 i think the ecb is going to have to display patience given what has happened in terms of growth in germany and globally. jonathan: the best measure of not just the german economy but the european economy, on the continent, is the german ten-year. to think about the confidence that we had coming into 2018, that the german ten-year yield would end the year lower than when it started. ira: that shocked a lot of people. it certainly was a surprise for us. i think one of the challenges for europe is how do they get out of this growth malaise? right? what is the way they get around it? at this point, there is little that monetary policy is going to be able to do. i mean, they have literally negative interest rates and that does not seem to have done the trick to get lift off for the economy. you know, you have had these little bumps. things have not deteriorated a

lot, but it is very, very unsatisfying growth. the inflation picture does not seem to be picking up. without some kind of coordinated fiscal response, it is hard to see how that changes or how the ecb and mario draghi can raise rates. jonathan: in the spring when everybody started coming on the program and saying to me that the risk in places like emerging markets was idiosyncratic, and i got sick of that word within a couple of weeks. and the surge of idiosyncratic risks very quickly became a this picture for systemic risks in 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 next year? noelle: these two points are kind of related because the european domestic market has been the place. employment is strong, wages are building, but externally, china is slowing down and we are dealing with a lot of uncertainties. we think that next year, they are going to focus more on fiscal policy and that is going to stabilize growth in china, thus kind of stabilizing growth

in em and europe. at least from the external side. and then the domestic picture is still well. jonathan: can we get that turnaround in em in the way that noelle thinks we can? tony: i think it is possible because i think you will see, hopefully, some stabilization in energy prices and global growth. so we are not predicting recession. i think 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 to emerging markets. if we can get the dollar to stabilize and the growth picture to again not be recessionary, but just healthy but lower growth, those are the ingredients for emerging markets to stabilize and begin to recover. jonathan: guys, looking ahead to 2019, we have to get 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. higher or lower, noelle? noelle: slightly higher. jonathan: ira? ira: lower. jonathan: tony? tony: slightly higher.

jonathan: does the curve invert before the fed hikes again? 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 or u.s. high yield. loans or high-yield? noelle: loans. ira: high-yield. tony: loans. jonathan: we have a market to close out the year around this desk. noelle corum from invesco fixed income, ira jersey from bloomberg intelligence, and tony rodriguez from nuveen asset management. guys, 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, 6:00 p.m. in london. happy new year. ♪

alix: oil's terrible quarter. crude falls the most since 2014. is the bottom in or should you brace for more downside? gold bulls are back. prices hit a six month high as equity markets fall and investors lose confidence in fed rate hikes. let the sunshine in -- i speak with john berger of sunnova energy about the opportunities for battery storage in 2019. i'm alix steel, and welcome to "bloomberg commodities edge." 30 minutes focused on the companies, the physical assets, and the trading behind the hottest commodities with the smartest voices in the business. first, let's kick it off with spot on.