jonathan: from new york city, i am jonathan ferro. bloomberg "real yield" starts right now. ♪ jonathan: coming up, chairman powell adjusts his tone, prepared to be flexible and patient. a blowout payroll report. u.s. employers adding the most workers in 10 months. having to whipsaw the treasury market, sending yields higher across the curve. we begin with the big issue, a monster jobs report. >> this is a great jobs report. >> it is a wild report. >> it was a blowout. >> it is basically telling you that the strength in the economy continues. >> this should give the fed confidence that it has the right

pulse on the economy. >> they must be very pleased. there must've been some exciting at the fed in the last few weeks given what's happening. >> for the fed, this is an i told you so. i told them so. the labor market is in really good shape. >> there is no inflation. there is no inflation. more growth, more people working does not cause inflation. these old federal reserve models are outdated and have proven to be incorrect. >> wages doesn't mean higher inflation. the fed should be -- what robert kaplan said yesterday is right, be patient. >> too much gloom and doom. i prefer boom. jonathan: joining me around the table is bob miller, jim karen, managing director of global fixed income and head of macro at morgan stanley, and from boston, margaret patel, a senior portfolio manager at wells

fargo. let's begin with the blowout payrolls report. margaret: i think it shows there is a lot of strength in the economy at the current time. labor indicators are a lagging indicator that doesn't necessarily predict the outlook for next year. i think that's what the market has been worried about. certainly, the economy is in good shape today but it will likely decelerate. jonathan: that is the problem. we've had one of the best payroll reports of the cycle, but everything else relative to expectations outside of the labor market and personal household sector is pointing south. bob: i think this is probably the is great labor market we will have for a while. i would not be surprised if we do not see a meaningful deceleration in hiring over the first quarter, first half of next year. when you cut equity prices by up to one half across the economy, it seems likely hiring will slow some. jonathan: do you agree with that? jim: i agree.

i think the retail numbers have been good and the hiring looks good and the weather has been pretty good too so that gives us a boost. we may have to pay that back later on. overall, i think the economy currently, as he was saying, is in good shape for now, how about over the next couple of months? it might be slower. jonathan: let's talk about what that means to the bond market. a big bid in the equity market to end the week. looking at thursday's price action at the front end of the treasury curve, you would think the world is coming to an end. what do you make of the moves at the backend this week? totally whipsawed, a real 180. margaret: rates have moved around a lot, but they are still very low compared to where they were the last year. it says that the market is really feeling concerned about the outlook for growth. i think the flat yield curve historically has not been a good indicator. the curve is really flat out to five years.

i think that is more important than a one-day rally or correction over the latest economic data. jonathan: a lot of people thought thursday's price action at the front end of the curve was overdone. i wonder how much of this will be reversed and how sustainable the reversal will be, and whether maybe thursday's price action was an indicator of what we are about to get in the coming six to 12 months. bob: yesterday seemed a bit aggressive. at one point, at the low yields of the day, we had about 15 or 20 basis points of easing priced in by the end of this year which seems a little aggressive. but frankly, the market has done a good job of pricing a fed on hold for an extended period of time. i think that's appropriate. if we back off 10 to 15 basis points, maybe 20 basis points from here, i think it's a good buying opportunity. jonathan: in many ways, the market has done a better job of telling this federal reserve where they will be than the federal reserve itself. jim: sentiment is fragile and i don't think positioning is clean. when we think about where we

were in terms of allocations of fixed income, i think people have money in cash and now we see a slowing economy going forward and i think people are wondering if maybe they should buy some longer-term bonds. perhaps they can hedge themselves against slower economic activity going into 2019. jonathan: the other person who weighed in on this is the chairman of the federal reserve. a blowout payrolls report followed by these comments by the federal reserve chairman. take a listen to what jay powell had to say. mr. powell: if we reached a different conclusion, we would not hesitate to make a change. if any aspect of normalization was part of the problem, we would not hesitate to make a change. jonathan: what do you think of that? a total 180 from the chairman. bob: i think it's appropriate. it might be three weeks delayed from what would have been optimal delivery time. but nonetheless, it appears the markets have been well ahead of the fed and the fed is catching up. i think a deceleration in growth

is baked in the cake. we were already going to decelerate from passing the peak fiscal impulse in the fourth quarter, early part of the seer, as well as monetary tightening over the last two years, and in december, the fed delivered a more hawkish expectation than the market was assuming and it reinforced the risk off, the elevated volatility for a while, and now it appears they are coming around. jonathan: there is a lot of people very unimpressed with the communication of the chairman of the federal reserve. it has been flip-flop after flip-flop. why haven't we heard more from this chairman? margaret: i think, frankly, he is not really sure how he should be communicating. i think in retrospect, even at the time, it looked as if raising rates in december was a mistake. i think now he is trying to talk his way around it. even though the talk has been gradual, the fact is, in the marketplace, liquidity has been drained out to put too much

strain on the system. it's not really an issue of talk or communicating, it is a matter of their actions, which have been too aggressive for the level of inflation, for the amount of liquidity in the system and for the amount of leverage, which says they need an even more gradual step if not actually ceasing to raise rates in the short term and slowing down, letting the balance sheet runoff. jim: i think it's almost as if somebody grabbed the report and said, read this piece of paper. this is what you need to say to make the markets happy. be flexible and think about your models but also look at the financial conditions and what the markets are telling you and do not weigh too much on your models. the market might have a better read. jonathan: are you anticipating more mistakes by the federal reserve chairman? and to what degree are those opportunities -- look at the situation right now. the market is doing a better job of predicting where the fed will

be than the fed themselves, and the chairman is doing a terrible job of communicating what the federal reserve will and won't do over the coming meetings. when he makes these kind of mistakes, are the opportunities? bob: yes, at the end of the day they are opportunities. they are creating unnecessary volatility. if you maintain flexibility in your portfolio, you should have the opportunity take advantage of some of those elevated vol periods. in a perfect world, the communication would be more clear and crisp. that said, it's not clear how we will move in that direction. jim: the increased volatility will come at a price. for an entry point into any investment, i want to have a better price. the risk premium will rise and that will cause volatility to be a little higher and the fluctuations in prices will continue to be very high, as we are seeing yesterday to today, as long as the fed chair is going to be inconsistent within his speech. jonathan: i want to get a better idea over who is willing and who is not willing to take duration risks given what we know here and now. have you changed your view?

bob: we have changed our view with respect to -- as you know, for the last six months or so we have liked the front end of the curve and i think you are supposed to move out into intermediates into the five to 10 year part of the curve. valuations have changed a fair amount but i think it's still a reasonable valuation given my expectation for growth and inflation over the next six months. jonathan: margaret? your thoughts? margaret: i don't think taking risk in duration is risky at all. we have been long duration for the last five years and gotten the extra yield from that and i still see rates in a trading range with a somewhat downward bias. i don't think duration is something to be afraid of. jim: i don't think there's a lot of upside to owning the front end right now. we've already priced out the fed. extending out a little bit toward the three to five-year point makes sense. i think you can pick up some extra yield. jonathan: guys, you are sticking with me. coming up on the program, the

auction block. u.s. high yields in investment grade issuance struggle to close the year. this is "real yield." ♪

jonathan: i'm jonathan ferro, this is bloomberg "real yield." i want to head to the auction block. it was a frigid month of december for high yield. for the first time in a decade, there was no issuance last month, in a year in which u.s. junk-bond sales dropped 42% to $190 billion. u.s. investment grade bonds closed 2018 with $1.1 trillion. this came after the slowest december since 1995.

typically through january, though it brings an onslaught of new deals, after a slow start, six high-grade debt borrowers hit the u.s. on thursday, including berkshire hathaway and ford. still with me are bob miller, jim karen, and margaret patel. margaret, to begin with, you want issuance, it was a very dry december. i want to get my hands around the maturity yield that will build through 2020. how big is it? margaret: i think the supply will continue to be relatively low. especially with this move up in rates. a lot of what would have come as issuance has been drained into the loan market rather than the high-yield bond market and that's a reason why supply has been so low. i'm not looking for any big increases in high-yield issuances this year. jim: i agree. i think the maturity wall is nothing to worry about, the yields are also higher right

now. they are almost 8%. last year, they were at 5.8% to close out january. i think there are some opportunities. the economy is slowing but it's not collapsing so default risk will still be in the low 2% level, versus the long-term average of 3% to 4%. i think there is still opportunity there and with lower supply, you will be better. bob: i agree with that. i think risk premiums have been rapidly restored to a number of asset classes as they have evaporated from risk free. i think risk-free is ok. there is some opportunity. i like up in the quality and up and liquidity because i think the growth impulse will slow some, i don't think it will collapse, but i think it will slow some. i would expect that to create a headwind for some of the more growth sensitive credit buckets, but valuations are ok. jonathan: to be more specific on high-yield, i think it was bank of america this week who said the compelling value would come in when spreads get to about 600 basis points.

is that in line with your thinking or are we already there? bob: i think it is ok here. i suspect they get a bit cheaper over the course of the quarter if we see the growth slowdown we anticipate. we are within the range of reasonable unless you are predicting recession. jonathan: margaret, is that your view as well? margaret: yes, a lot of the poor quality issuers we may have seen previously in cycles have been drained off from the loan market so high-yield is good. when you look at the issuance over the last half-dozen years, over half the issuance has been to refund other debt. i would say high-yield companies have never been in such great shape balance sheet wise to withstand a decline in their cash flow. they are not beholden to the banks like in previous cycles. they will be able to get through it. i think default will be relatively low. we may have a little bit of an increase as the economy slows down, but i think there is pretty good value in the high-yield market. 6% to 8%. jonathan: many of those

companies, those that had to issue debt issued leveraged loans. there was a big incentive to do that. there was massive supply met by massive demand. if you have the decision to make this year, where does that supply drop? into loans or high-yield debt? margaret: i think at the margin, it depends on the cost of financing. i think there is still a huge amount of loans that would like to be issued and there is pretty good demand for that. on the corporate side, i think the demand for long-term high-yield bonds is frankly insatiable for long-term investors. you can get bonds at 6%, 7%, or even 8%. so there will be no difficulty in demand. it is more, will companies be willing to issue at these elevated rates? jim: when you think about the risk premium, a lot of that has been restored so you look at oil and energy. if you think the global economy is collapsing, maybe that's not the right sector. if you think we have hit bottom or are trying to find a bottom, those sectors look like they have been sufficiently beaten up

that it looks interesting. same thing with transport and communications. these are areas that will give you that 7% or 8% potential yield, and even in some cases, higher. i think there is good opportunity here if we think about real economic growth being stable. jonathan: what about loans? what are you guys thinking at the moment? i catch up with your colleague rick reiter a lot and we talk about the attractiveness. i would say the attractiveness has diminished somewhat since the federal reserve is looking at doing nothing this year. bob: totally agree. like it's time to move out of the front end to the intermediates, and it's kind of move out of the floating to the fixed. the fed is increasingly signaling they are likely to be on pause for an extended period of time. given the valuations in these fixed rate asset classes, you should make some capital into fixed. jonathan: does that resonate with you, margaret? margaret: yes. another reason high-yield is attractive is there is a big price discount. a year ago, high-yield bonds were trading at premiums. right now, most bonds are

trading at a discount. if we have yields go down, you can have some capital appreciation and not have it cut off the way you do in loans, where your loans will be called away. another reason where total return, high-yield looks good this year. jim: i agree, i would rather own some duration in high-yield and manage the interest rate risk through interest rate futures. jonathan: great to have you with me. you are sticking with me. bob miller, jim karen, and margaret patel. a check on where the treasury market has been through the week. what a week it has been. thursday, yields higher, yields lower, rather. aggressively lower. friday, yields higher and this is what you end up with. a remarkable week. still ahead, the final spread, the week ahead featuring more comments from jay powell and fresh data on u.s. inflation. this is bloomberg "real yield." ♪

jonathan: i'm jonathan ferro, this is bloomberg "real yield," and it's time for the final spread. a massive week ahead that starts on monday when a u.s. delegation is in beijing for trade talks with chinese officials. you will have minutes from the fomc and ecb, and fed chair jay powell speaks once again and we get the u.s. inflation report. my guests are still with me. margaret, what are you looking for from the fed chair? margaret: i'm not sure. i think he needs to talk less and think more creatively, and maybe assure the market that they realize that they may need to adjust monetary policy more practically, or give some hint that they are closer to the end of the process and raising rates, or about the speed of

letting the balance sheet runoff. i think a little bit more specifics. it's not a question of style, but facts, and something to show he is sensitive to liquidity in the effect on the economy. jonathan: just floating the idea of flexibility seems to have calmed some of nerves, is it enough? bob: i think the fed has been dismissive of the effect of the balance sheet and their drag on global liquidity growth. i think that needs to be recognized. it will be nice if they articulate a longer pause period as chair powell said in late november, to allow for time to observe the lag effects of prior tightening. eventually, they have got to deal with the balance sheet, and i fear it will be a slow-moving process. jonathan: there may also be a meeting with the president of the united states.

i caught up with u.s. official larry kudlow to talk about just that. take a listen. larry: frank and candid exchange of views? [laughter] larry: i think it would be nice to have a frank and candid exchange of views, shall we say, up close and personal. i think president trump would benefit and i think jay powell would benefit. jonathan: larry kudlow there earlier on. margaret, your view on what a meeting between the chairman of the fed and the president of the united states would mean to you. it's not unusual for the president to meet with the fed chair. it's not unusual for the leader of any central bank to meet with the leader of the country. it's a very peculiar time right now. margaret: i think it would be a very good thing because here you have two of the most important individuals in our government, and for them to communicate and exchange ideas and opinions and facts would be very important. yes, the fed should be independent, but the fed should really be empathetic with the

role of government and its affect on the real economy. i think president trump could learn some things about how the fed operates and the things the fed is looking at. it's not an easy job the fed has, especially when they rely on historic business cycles at a time of zero money policy, things we have today are very distorted. so it's a difficult time for the fed because the past is not future, and that's one of their big problems is thinking this is a normal cycle and they will do what they did in other cycles. jonathan: it's a really difficult time for the federal reserve, and the president of united states. it is funny that the president of the united states makes a comment on monetary policy and when he says things like the fed chairman needs to feel the market more, people laugh at the president, except he was right. that's what the fed chairman did to close out the week. he was more sensitive to the market, wasn't he? jim: what we are all trying to solve for is where does that fed put strike. at what asset price does the fed

think they need to something? we got some information 20 end of last year with the markets doing what they did, that this opted today's comments by powell. at the end of the day, the fed is there to support the markets and let us know they are there to be that support. knowing where the fed put is struck will be helpful. jonathan: we always wrap up the show with three quick questions. hopefully three quick answers. to begin with the first question, is the next move from the fed a hike or a cut? bob: cut. jim: cut. margaret: do nothing. jonathan: a hike or a cut after that? margaret: i would say it's a coin toss but i would lean toward considering cutting. jonathan: i have to put you on the spot. are you willing to face the curve inversion or do we get it before year end? bob: no. jim: yes. margaret: yes.

jonathan: the ultimate pain trade for treasury yield, is it higher or lower? i'm trying to figure this out? bob: in the near term, i think it is lower on the front end, although a lot has been cleaned up. jim: higher yields. margaret: i think stable to lower yields. jonathan: great to have you with us on the program. what a week it has been. for my guests, this was bloomberg "real yield." ♪

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