jonathan ferro. a special edition of bloomberg real yield start right now. coming up, markets throwing a tantrum. reduction on autopilot. doubts increasing on whether president trump can hike rates before his term ends. some series concerns. we start with the big issue, going into 2019, uncertainty. >> there is significant uncertainty about the path and destination. >> uncertainty is playing in a big way. >> raising of uncertainty.

>> uncertainty about global growth. >> markets of gun spoonfed for so long that any big change upsets them. is not high on the fed's list of things to pay attention to. >> not going home on the yield curve. the yieldo normal on curve. as it flattens it is telling us that monetary policy is being to restrictive. >> markets got used to this ever-increasing amount or study a flow -- steady flow of liquidity. i would love the balance sheet acknowledgment of it to be on the list. that seems hell-bent for what we will keep doing what we have been doing. economy may not be kind to our forecast next year as it was this year. jonathan: joining me is no local room. our chief u.s. interest rate strategist and bloomberg intelligence coming to us from minneapolis.

fixed income strategist and asset management. let's begin with you. year and forecast pretty for -- typically pretty useless. >> as you mentioned, that is the certainty of 2019. the amount of uncertainty. we are thinking about it in three main macro buckets. each of those macro buckets have , they all work together and they all drive asset prices. growth, which would be as moderating, but still -- which will be noisy as tariffs are noisy. and the financial conditions are 2018, 2018, the driver of markets. that's why you saw the underperformance in credit. looking forward, we do expect fetes to continue. we expect the fed to be battling between a solid growth picture and tightening financial conditions.

intopect to see tightening q1 and a little bit of q2 of next year. that is why we stay offensive on credit. think that the uncertainty next year is going to come around the fed mostly. regardless of what happens with the economy in the first quarter, i think the question is still going to be is the fed actually going to go to times next year or are they not. we are mincing this. pointsically, 25 basis in overnight rates enough to derail the economy, the answer is probably not. it has to go confidence in the boardroom. animal spirit. whether or not the people think the fed will make a policy mistake. jonathan: it is not the first time we have had tension between the markets and federal reserve. i am trying to get my head around whether the tension is overrated or the balance sheet. i think is both because i think the fed has been chasing the market. we have -- on multiple

occasions. i think that is what we will see an 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 dogmatic around the balance sheet. the market clearly knows the liquidity of the balance sheet reduction is taking out of the market has been a negative, has increased volatility. i think if the fed were to show some flexibility on the balance sheet, which would make sense, that would help quite a bit in terms of reducing some of the volatility of the market. it isk you are right, double-barreled both on the rate and the balance sheet. i think you will see the fed continue to be playing catch-up with the market. as they reduce their projected level of both rate hikes and maybe modify the autopilot that the balance sheet seems to be on. jonathan: to pick up the comments, i certainly don't want to do that appeared money gets supported on the show many times in the here. was is interesting, that

not the focus. the coming out of it very much was. why? thate: the fed has showed the balance sheet is not going to be a 2019 story. it has been a focus because the financial conditions tightening, love the market thinks that is a liquidity issue. in fact, it is a global financial conditions have been tightening. it has been hitting credit from a global perspective. also seeing domestic financial conditions tightening with the fed. --lle: ira: i am passionate about this because her make too big of a deal about the pace of balance sheet. for one thing, the balance sheet unwind peaks in the middle of 2019. and then it gets smaller. automatically, we will have let's -- let's ounce sheet unwind then we have had over the last six months. not just mathematics, what the fed owns and what is running off. reserve, the federal

will most likely stop hiking before it and its balance sheet reduction. atworst, they will do both the same time. financial conditions have gone so tight. the one thing that the balance sheet reduction certainly has come at this is one of the reasons why people talk about this liquidity, when you look at effective money growth, it is basically stopped. it was 5% for the last few years come of this year, it is less than 2%. it has sloan down so much and that has an effect on growth and inflation. jonathan: you brought up an important topic. i want to ask the question to you. whether this market is starting to price a policy are era and what that looks like. think it is pricing in a policy error because the fed chasing the market as they reduce their terminal rate is really the idea that if they stick to their plan, i think that is a policy error. if they go with to tightening's

next year in balance sheet complete on autopilot, i think that would be a policy error. i think they will actually come forward next year, first, through speeches, and then in the meetings and further reduce their projected path and i would expect the next year to see one tightening or you may see none depending on what the data actually tells us. are data dependent. they are having trouble having communication keep up with how data dependent they are going to have to be peered the risk of a policy error is high if they stick to their plan. you have policy errors that can hit the markets on the trade side and in europe. i think the policy risk is high. andink the uncertainty economic data and growth, we agree we will see moderation in 2019. moreurse, that maybe severe than we are expecting. that risk has to be priced in. when you combine those, you get a volatile market, repricing of risk.

you get cautious investors. noelle: i think that -- ira: i think the fact is the fed is chasing the market. they were all is priced for about one hike. now we are less than one hike even though the december docs says they will only do too. that is something that is likely to continue going into 2019. the fed chases the market down. jonathan: it seems the federal reserve has a communication problem. you can't have a chalmette -- chairman that is very hawkish and a month later, very dovish. and a month later, terribly confused. those three things are stacked up around about two months. 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? tolle: they have been trying stick to this data dependence. a lot of the data has not deteriorated. i would not disagree with you on this one. it has not dictate -- deteriorated in a significant way. that is why they seem confused because financial conditions

could start to seed into the data. in ahave not seen that significant way. that is why they are not backing down. we don't expect them to in the near term. we are only calling for to hikes next year. are in ahat companies decent spot to absorb those hikes. i think the market is pricing in a little bit of a policy error. is come over committees are fundamentally, if it happens gradually enough, we can withstand that. jonathan: the spread between the market and fed is not that big. the biggest mistake in the news conference, two questions back-to-back, inflation is going to under target for another year. why are you raising interest rates? and you could not answer the question properly, why not? tony: that is what i was going to bring up. that is part of the confusion in

the market. when you reduce your growth projection and your inflation predict -- projection, at a level that is below your target, clearly very clustered, that seems inconsistent to the market. still talking about two tightening's next year when you are forecasting 1.9% inflation into 2020. that is where the fed needs to be -- do a better job of communicating to the market. the reality is that the communication will be that they won't be as aggressive as the current path dictates. that, that will help the market stabilize, for now, with poor liquidity conditions, with equity markets that are really suffering quite a bit in the fourth quarter, i think you will see in the beginning of 2019, still the uncertainty in the market and the volatility.

it is likely to take place, given our outlook for relatively reasonable growth pictures, slower but still in that recession, i think it will take if months for the market to digest that. jonathan: you will be sticking with me. tony, no well, and ira. from bloomberg intelligence. the auction block. we are review of the year it was in supply. this is bloomberg real yield's. ♪

this is bloomberg real yield and i want to head to the auction block and take a look at the issuance numbers.

we start with the u.s. treasury in the calendar year, there has been $1.3 trillion in net new cash. this number dwarfing previous years. sales flow to levels we have not seen since 2008. massive outflows in high-yield funds. a search, roughly $800 billion in new -- was issued. this comes as the price index tumbles to close out the year. still with us. i have asked many people what 2019 will bring to credit. it is going to be extremely tough. credit will be stuck between the battle of growth and the fed or global financial conditions in general. because you have a fed that is just watching the data and the growth the growth data continues to look solid.

credits will be from both sides because of that. it is going to be tough. we do expect the fed to respond accordingly. it has been very open and willing to respond, if it sees through the data. that is what they are waiting for in a significant way. corporate's are fundamentally solid. they are at and in position where they can stop their share buybacks and pay down debt. as long as these things are gradual, as long as we don't see a massive slowdown in growth, we think they will be able to absorb both the fed and any slower growth trajectory. jonathan: this is an important point of tension. a disconnect we have with the markets economy here in the united states. when it can become real. the fact of the matter is when they should be or should not become a spread year wide, the

fact of the matter is for leverage loans, when they come back to the market, they will be paying higher interest rates. can it become real? can the technicals become fundamental? tony: they can. we don't think they have reached that level. at some point, there will be a pretty good entry point. the fundamentals, we think, despite the liquidity conditions that have raised financing cost and limited access to financing, we think that will clear up over the course of the first two months of 2019. we think it certainly can. i don't think you will see that happening this particular cycle. we are more likely to see an extension of the credit cycle as liquidity conditions stabilize and improve in the first quarter. ira: i think there are two interesting things. seenthis selloff, you have a much wider dispersion of

credit. that has been some credits have underperformed massively and others that have not done that badly. -- the market is discerning a little bit. secondly, there is -- there is not a potential systemic problem where if corporations decide that we don't want to issue bonds, they might not. because of the rally you have had in rates and yields, for investing great firms, even triple b's, the yield today is lower than november. you have this environment where funding is not particularly expensive for a lot of these companies. jonathan: the funding market has tightened up. is in pocket for a lot of people. it is a vicious cycle. you can't issue because the demand will be there. the whole thing just starts doing it. how do you break that cycle in leverage loans? we think q1 will be tougher in general. a loans included.

looking into the year in 2019, that cycle needs to be broken by financial conditions stabilizing because growth is not that bad. we think europe and china growth in general will be supported by stabilization. so, we need the fed to step in and stick to their word. we are talking about the fundamentals but we are talking about the liquidity and potential for a mismatch. incrementally, increasing the fire of this universe and leverage loans of 2018 with real -- retail and we have seen retail start to hit the exit in a big way. quite clearly, liquidity mismatch between -- the contract, the loans, are we set up for an accident? i certainly think that has the ingredients for an accident. at the same time, margaret has the mechanisms to avoid that.

some of those bars can move through the high-yield market, they can go to the banks directly for some of that lending. the repricing we have seen, loans were yielding, maybe 250 basis points less than a high-yield market. that has collapsed to levels we have not seen since 2000 seven. 30, 40, 50 basis points. the repricing makes the clo far more attractive to the investor. i think you can see a recovery in the clo market. because of the repricing change in relative attractiveness of it to a point that is very competitive with the high-yield market and other yield segments of the fixed income market. jonathan: you will be sticking with me. coming up, still ahead, the week ahead. featuring comments from jay powell in the first job report of 2019. that is next. this is bloomberg real yield. ♪

is bloomberg real yield. time for the final spread, coming up with the next week after paper around the world have done ringing in the new year. we will have the opening day for the 116th congress. jay powell will speak and the first u.s. report of 2019. still with us, no well, ira, and tony. off the week, for 2019, jay powell coming up, these are the most interesting central bank, won't be the fed, the ecp. how does the president look to raise interest rates before he heads to the exits? you are right or he cannot do that. right now, the economy, high rates not paying. i think he will have a communication issue as well.

to try to get the market to be comfortable with what the ecb will do. i think the ecb is going to have to display patience and what is happened in terms of growth in germany and globally. jonathan: i think the best measure of being the european economy, the continent, the german ten-year. to think with enthusiasm and confidence that we have had coming into the new year and 28 income of the year lower than when it started. jonathan: -- noelle: i think that shock a lot of people. one of the challenges for europe is how did they get out of this they havee it negative interest rates. that's not seem to have done the trick to get lift off for the economy. they have had a little bumps. things have deteriorated a lot. very unsatisfying growth and inflation picture that does not

-- jonathan: -- in the spring, when it started coming up on the program and saying risk in places like emerging markets with -- i got to that word within a couple of weeks. the surge of idiosyncratic risk, very quickly became a picture of systemic risk in the emerging markets. that was the leading indicator for the global marketplace. it was the tension in emerging markets. how does that play out next year ? noelle: these two points are related. domestically, europe is ok. ismployment is -- employment strong, wages are building. externally, we have china has been slowing down and 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, that is stabilizing growth and em and europe at least from the external side, and the domestic picture is still well. jonathan: can we get that turned around? possiblehink it is because you will see stabilization in energy prices and global growth. we are not predicting recession. i think that will help a lot. fed backing off. it will take a little steam out of the dollar. one of the largest headwinds to an emerging market. if we can get the dollar stabilized and growth picture to not be recessionary, but just healthy, lower growth, i think those are the ingredients for the emerging markets to stabilize and begin to recover. looking ahead to 2019, we need the final rapidfire round of 2018. quick questions, quick answers. higher or lower by year end 2019? noelle: slightly higher. ira: lower. tony: slightly higher.

jonathan: does the curve inverted for the fed hikes again? noelle: no. ira: yes. tony: unlikely. jonathan: looking ahead to next year, a performance in leverage loans or u.s. high-yield? noelle: loans. ira: high-yield. tony: loans. guys, it has been great to have you with us, great to have you with us all year. looking ahead to next year, 1:00 new york time, 6:00 in london. happy new year. ♪

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