jonathan: from new york city, i am jonathan ferro. "bloomberg real yield" starts right now. ♪ jonathan: coming up, federal reserve officials observe willingness to be patient with rate increases. how to restore confidence in credit. leverage loans recovering and money flowing back into high-yield. leading to a thaw in the primary markets. we begin with a big issue. one word dominating federal reserve communication. >> patience. >> patience. >> patience. >> you are waiting and watching. >> patience, flexible, data dependent. >> ultimately what they are

trying to do is best telegraph their intentions. >> the one thing they got the fed nervous is the financial markets. >> none of us know because we are looking at the incremental development, not just economically, not just in markets, but geopolitically. >> we are in a place were we can be patient and flexible and wait and see what does evolve. for the meantime, we are waiting and watching. jonathan: a full house around the table in new york city today. joining me, lisa hornby, mary bowers, and tom atteberry at first pacific advisors. lisa, the good news is from the committee we finally have a coherent message from the fomc. lisa: i guess it is semi-coherent at this point. if you look at the difference between the dots, everybody says the fed is trying to transmit a more patient message.

in december powell had a completely different message. if you look at the difference between the dots for 2019, there is an 80-basis point spread between the members of the fomc. i think it tells you they don't know what is going to happen. they are looking at markets the same way we are. they are looking at data the same way. i think they definitely have given more credence to the fact markets are concerned. jonathan: if you take the message of patience, that is a coherent message. the communication effort. the difference you pointed out is in the dot plot. there is still a big spread between what they all expect in the coming 12 months. what do you listen to? tom: you have to listen to the communication. when you think about tying the two together, i get a person and i get their message. i can get more of a thought of where i think they are today versus a dot plot that is more opaque and historic looking. mary: i tend to agree.

the patience message is being digested by the market. we will have to see. but i think that it is a bit clearer than we had maybe leading into the year. certainly we have seen markets rally off of that. jonathan: the good news, the economic data so far, the jobless claims look rocksolid. the real-time indicator of the u.s. economy looks totally fine. if you're worried about inflation, it does not look like that is happening either. it's the federal reserve decides they want to wait around for the tension in markets and economic data, between the two to clean out, they have the time. lisa: i think that is true and they are paying attention to the fact they are doing a two variable experiments. they are doing the balance sheets and hiking rates. before they just thought the balance sheet was in the background. it was on autopilot, they'll have to think about it. but the market said we are kind of concerned about this tightening liquidity provision. that being said, when i look at

what is discounted today, which is absolutely nothing, no hikes this year, the market has taken that patience message and maybe extrapolated it a bit too much. i don't think the economy at this juncture warrants zero rate hikes in 2019. jonathan: do you agree basically that patience means nothing? no more hikes for the time being? tom: i think to a degree because , as you said, you have this to factor model they are working on, they seem to be good at working out how to raise short-term interest rates. they have lots of history, lots of experience, lots of things to talk about. they really have no idea after they bought this $3 trillion worth of assets, hattaway get out of the room i got into? it appears they are trying to be patient and trying to talk to try to ease the fact that i'm going to be getting out of the $3 trillion, some of the $3

trillion of securities i own, i'm going to try to do it without impacting anybody, which is extremely difficult to do , given your objective, to impact the market. if you are going to exit, you are probably going to impact it on the way out. patience is a way for them to talk their way through it. jonathan: something i struggle with, when the balance sheet became so important to the market. this happened in the background for quite a while. december came around and all of a sudden people started to pound the table about it. why? tom: when you look at their holdings and they said we are going to use a periodic autopilot, they did not have to reinvest things that were just maturing. now you have gotten toward the end of the year when we look at the maturity strength in what they are trying to accomplish is shrinking. there are periods of time for -- time where the maturities are

not going to cover it. they may have to do something else. or rates have risen. mortgages are not a payoff as fast as you thought. it is not as automatic. that is why the market might be thinking, you will start to impact the markets a little bit if you are going to try to accomplish that objective. jonathan: what are we actually talking about? i hear the word liquidity thrown around a lot. we're not talking about bank funding liquidity. what kind of liquidity are we really talking about, that the balance sheet seems to have a direct impact? mary: for high-yield it is much around the sentiment and the risk assets if we think the market is not open, that's a problem. we have seen high-yield have a pretty strong start to the year. we saw the first new issue come to the market yesterday. as we look at investment-grade, spreads have not tightened in the same way. there is a lot of debt out there. i tend to agree probably when we

think about the fed, we think the market is at risk of maybe underpricing a bit here. that can lead to continued volatility over this year. jonathan: we can talk about credit a little later in the program. i want to focus on the idea that the balance sheet matters. what is it that really matters to market participants? is it a psychological or indirect channel we all worry about? lisa: the fact that had so was -- that we had so much liquidity chasing few assets. there has been tremendous amounts of issuance. if you look at the aggregate amount of debt outstanding over the last decade, for a time it was contracting because the fed and other central banks were taking debt out of the market. that pushed people from treasuries into i.t. credit, to high-yield, to em, etc., etc. now there is less need for that. the other thing that is happening is the front end rates in the u.s. are now compelling

for the first time in a decade. you add another 100 basis points for investment-grade credit, is a 3.5% yield for a two-year bond. that is not tragic and it's a nice place to park cash. jonathan: i want to wreck up this segment by talking about the various kinks in the market at the moment. risk appetite improved over the last week. you saw credit snapback in a massive way, high-yield leverage loans. i would have expected if the money came out of the front end for yields to rise and that explains itself. to really take a fundamental, positive view on the u.s. economy, i would've seen some steepness come into the curve. why is the yield curve essentially flatter than where it was last week, even though things seem to have improved substantially and the fed has backed away? tom: what is a flat yield curve trying to tell you as an investor? it is saying investors in general -- i don't have a fear of inflation because i am not demanding a higher return to tie up my money for a longer time. i don't require a higher yield in the 10-year that i do with a two-year.

it is somewhat inflation driven. if i think the fed away and some people put fingers on things they are not supposed to. if i further look at the curve, the concerning part with the snapback in credit is high yield curves are usually followed by a decline in rates. don't know when, but a declining rates, and a decline in the economic activity. the decline in economic activity tends to happens 12 to 24 months after the curve flattens to the levels we saw not only this year but the last year. is the curve trying to tell me the economy is slowing down and i'm not fearful of inflation? that's why, even as you talked about the market nuances in the last couple of weeks, it is not impacting the picture you are looking at. lisa: i completely agree with that. i think there will be periods over the next 12 months or so where we will see steepening and

some flattening, because at some i believe rate hikes will be point priced into the market and you will have the front end lifting. jonathan: lisa hornby will stick with us, along with mary bowers and tom atteberry. coming up, the auction block. we raise our glass to the return of issuance. already, it is back. this is "bloomberg real yield." ♪

♪ jonathan: i'm jonathan ferro. this is "bloomberg real yield." i want to head to the auction block. we have seen a steep decline at treasury bond auctions over the last 12 months. the first not auction of 2019 saw demand fall to a near decade low for the sale of three having your bonds.

-- three-year bonds. , elsewhere corporate issuance , beginning to thaw. amassnvest was able to $41 billion in order for a $50.5 transaction. finally, the drought is over. the first company to so u.s. junk bonds in more than six weeks, it doubled to $1.5 billion in an initial $17 billion. still with me lisa hornby, mary bowers and tom atteberry. we finally had a primary test for high-yield in a way we have not had in about six weeks. your thoughts on that test and where do we go from here in terms of issuance. mary: the deal was well-received. it did come at a bit of a discount, but compared to other discounts we are seeing for high-yield, it is not too bad. it is traded well. that's a good sign for the market. it is a higher quality issuer.

buble be rated -- double rated. the way we have seen spreads come back in from the wides at the end of december, the market will be looking for quality more so than some of the lower tier issuers in the market. i don't think it is necessarily open to all, but at a price before the better capitalized names, yeah, the market will probably be open here. jonathan: where does this apply -- the supply comes from from this year? high-yield was very dry in 2018. does that change over the coming months or is it a replay of last year? mary: for now it seems like we should see a kind of replay. we won't see the same refinancings we have seen in the last couple of years in high-yield. lbo reissue supply was going to leverage loans. if that market is still open and

the clo demand can come back, that is probably where we will see the supply coming. i don't see from a supplies perspective issues for high-yield. it is more in the overall credit quality of the broader credit market. you have to think about investment-grade leverage loan and high-yield, and really take that as a bigger picture when thinking about any part of these markets. tom: thinking through it to our way of thinking, the investment-grade space of the two things you mentioned in your opening of the segment is the more important. the bbb corporate is where the pain point appears to be greater than if i look at the most high-yield markets. ok, you are highly leveraged. you have been able to exist because your interest costs are low. can you turn this out while interest costs are so low and survive? if it is unable to, you have a higher propensity or probability

bb or singleinto a b rating. now you have a cohort of analysts that looking you enter willing to own you. you as issuer, your world changes rather dramatically when that happens. jonathan: let's talk about what has performed so far in 2019. we have had an aggressive snapback off of december lows, the same and high-yield. why hasn't investment-grade participated in the same way? because of the concerns you were picking on right now? tom: we would say yes, it is the concern. keep in mind, half of it is bbb. if we think back to the beginning of this economic cycle, only about 35% was bbb. at the same time, that whole segment of the margaret -- the market a little more than doubled in size. lisa: i agree with everything these guys have said. for high-yield in particular, a really rough fourth-quarter.

there was potentially a bit of a dislocation from some of the underlying fundamentals. certainly in some of the companies, where it was very sentiment driven. we saw an aggressive snapback. the technicals ultimately were supportive of that market. as you mentioned, the first issuance in six weeks, that hasn't happened since 2008. i am not a high-yield person specifically. jonathan: the first month of having no issuance whatsoever in december since 2008. lisa: cash balances potentially got low for many. or there was some appetite there. i think the other point i would make is, my high-yield colleagues have mentioned the default rate being discounted in the market well in access of an -- well in excess of what expectations are. something like 4% or 4.5%, next rotations are for a 2% default rate. jonathan: the interesting part for me is the base case for 2019. for a lot of people like year-end, were going to get what

we have got in the first couple weeks. does that make things a bit complicated for you? mary: it will be a long year, that's for sure. when we think back to december and the fourth quarter for high-yield, half of that spread widening happened in the last two weeks of december. there was basically no liquidity in the market and that was a lot of what drove that, maybe what we thought was overdone in terms of spreads. we are not surprised to see the snapback. 450 in spreads is not wide. 550 is not that wide either. if we had a year where spreads stay right around 550, half your returns are already done. we are at 450. granted, when we look at growth potentially slowing in the u.s. and worldwide and some of the liquidity coming out of the market, that should lead to wider spreads. we are still quite cautious.

if anything right now, we are probably de-risking a bit more into this. jonathan: it is a tough time to think about this. for the people who have been waiting for 600, they have been waiting for a long time. at some point last year, or even later than that, he said if you wait for that kind of level, it is not coming. you will miss out. i just wonder, why is 2019 any different to that? tom: we wrote a piece at the beginning of 2018 and talked about how markets, fixed-income markets, act when you get into a flat yield curve. one of the things historically you notice, they do not do too terribly well. volatility tends to go up and returns go down. we are a little flatter in the yield curve now than we were a year ago. so, thinking after 2019, probably should not expect that much different from what i saw

in 2018. to a comment about waiting for 600 or some other number, when you look at high-yields especially, ok, if i buy this bond with the yield index today at 7.25% or 7.5%, the best that will happen to me if i owned that and he pays me back in interest and dividends, i will make 7.5%. if something goes awry, i will make less than that. you are looking at this and realize you are making an equity-like investment. you are going, i really should get equity returns. that is why at times to us you sit and wait for the 600, because you are worried more about all the things that could go wrong versus the handful of things that could go right. as you prepare for the worst and hope for the best. in high-yield, the hope for the best is to pay your interest payments and then pay your principle back. jonathan: some really good

thoughts. you're going to stick with me. lisa hornby, mary bowers and tom atteberry. i want to get a market track -- check on where treasuries have been through the week. 'tis, tens, 30's, yields up high just 4 basis points on a , 30-year. marginally high on the 10 year as well. still ahead, the final spread. the week ahead, featuring earnings from big u.s. eggs, and political deadlock in united kingdom and the united states. this is "bloomberg real yield." ♪

♪ i'm jonathan ferro. this is "bloomberg real yield." time for the final spread. coming up over the next week, earnings season begins in united states. major u.s. banks like citi, jpmorgan and bank of america report. plus, the expected brexit vote in the u k parliament. comments from mario draghi, and

governor kuroda coming up as well. and we hit record territory in the united states for the length of a government shutdown. lisa hornby, mary bowers and tom atteberry. i want to pick up there quickly and briefly if we can. if the bloomberg terminal had a headline that the president declared a state of emergency, would that mean anything all to market participants or just be noise? tom: you have to look at it from are you an investor or a trader? we are not traders. even if i was, i would look at that news and go, wow i have no , way of understanding it will go this direction or the other. job is aestor, my steward of capital, those sorts of things, you have to ignore them and go what is the best for , the capital we are responsible

for deploying, and you kind of have to push it asave to push i. lisa: i agree. i think, if anything, it means the government shutdown is over because they declared a state of emergency and congress can now pass a budget, that is good. people are back to work, getting their paychecks. the data is back. we are missing data because of this. if anything, it removes some noise in the background. jonathan: i have heard a few people make that bullish argument. we are going to wrap up the program with the rapidfire around right here on "bloomberg real yield." fed, at move from the rate hike or rate cut? lisa: hike. mary: hike. tom: cut. jonathan: interesting. treasury curve positioning. what is your position? steepener or flatten or? -- flattener. lisa: initially steepener, later flattening. mary: i agree with lisa.

tom: steepener. jonathan: retest the wides of december for high-yield, or is the worst past for 2019? lisa: retest. mary: retest and then possibly more. tom: retest. jonathan: interesting stuff. take you for joining me for the last 30 minutes. lisa hornby, mary bowers and tom atteberry. york, that doesn't it for us, we will see you next at friday 1:00 p.m. new york time. for our audience worldwide, this was "bloomberg real yield." this is bloomberg tv. ♪ amazon prime video is now on xfinity x1.

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its all included with your amazon prime membership. that's how xfinity makes tv... simple. easy. awesome. yousef: headlines this week. and opececonomy production cuts. wti breaks $50 a barrel. goldman sachs reduces its 2019 forecast for oil and metals. we look at why. and the divide property slump puts developers amongst the worst in emerging markets. is there any sign of relief? ♪ yousef: