♪ jonathan: from new york city, i am jonathan ferro. "bloomberg real yield" starts right now. ♪ jonathan: coming up, federal reserve officials hammering home 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. the first junk bond issuance in six weeks. we begin with a big issue. one word dominating federal reserve communication. >> patience. >> patience. >> patience for pause. >> you are waiting and watching. >> patience, flexible, data

dependent. >> ultimately what they are trying to do is best telegraph their intentions. >> the one thing that got the fed nervous is the financial markets. >> none of us know because we are looking at the incremental developments 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 this week. 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? the communication or the forecast? 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. jonathan: what do you think? 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. it is a real-time indicator of the u.s. economy that looks totally fine. if you're worried about inflation, it does not look like that is happening either. if 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. the data is on their side. lisa: i think that is true and they are paying attention to the fact they are doing a two variable experiment. they are doing the balance sheets and hiking rates. before they just thought the balance sheet was in the background. it was on autopilot and they did not 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 two two fact or model -- 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, how do i 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 i find extremely difficult to do, given your objective, to impact the market when you entered this purchasing program. if you are going to exit, you are probably going to impact it on the way out. i think this patience piece 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 of reinvestment, 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

that maturity that maturity stream in what they are trying to accomplish is shrinking. there are periods of time where the maturities are not going to cover it. they may have to do something else. cover it. they may have to do something else. our rates have risen and mortgages are not a payoff as fast as you thought. it is not as automatic. 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 for issuers 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. trying to understand why it matters, what is it that really matters to market participants? is this a psychological issue or a direct channel we all worry about? lisa: the fact 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 ig 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.

2.5% you add another 100 basis , points for investment-grade credit, you are talking about 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 wrap 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 have thought some steepness would 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: if you traditionally think about 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 than i do in 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 decline in 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. i look at this as, 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. jonathan: what do you think, 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

point i believe rate hikes will be repriced 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 -- in demand at treasury bond auctions over the last 12 months. the auction of 2019 saw demand first fall to a near decade low for the sale of three-year bonds.

elsewhere, corporate issuance beginning to thaw. the investment-grade market past the test this week and was -- recently downgraded ab invest, was able to amass $41 billion in order for a $50.5 billion jumbo transaction. finally, in high-yield the drought is over. the first company to so u.s. junk bonds in more than six weeks, it doubled to $1.5 billion from an initial $750 million. 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 on investment-grade no issuance 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. bb 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 the supply comes from from this year? a lot of it came from leveraged loans last 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. supply wasissue 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.

but i do not see from a supply 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. jonathan: tom? 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 into most of the 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 still reasonably low and survive? if it is unable to, you have a higher propensity or probability

of slipping into a bb or single b rating. now you have a whole different cohort of analysts that looking and a cohort of people 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 in 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. thinking back to investment-grade and putting it in a big asset class 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 market a little more than doubled in size. jonathan: lisa? 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 excess of what expectations are. something like 4% or 4.5%, next -- when actually rotations are for a 2% default rate. that is part of it as well. jonathan: the interesting part for me is the base case for

2019. for p flow by year-end, we are 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. even if we were going to have a year where spreads stay right around 550, half your returns are already done. we are at 450 in spread. 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. a member of it came on this said iflast year and 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. out to 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, more than investment, it says 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 it 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. ands a very levered entity you are going, i really should get equity returns. and 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 we put it, 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 check on where treasuries have been through the week. twos, tens, 30's, yields up high, just 4 basis points on a 30-year. marginally high on the 10 year as well. right around 2.7%. still ahead, the final spread. the week ahead, featuring earnings from big u.s. banks, and political deadlock in united kingdom and the united states. this is "bloomberg real yield." ♪

♪ jonathan: 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, goldman, jpmorgan and bank of america report. plus, the expected brexit vote in the uk parliament. look out for that. 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. still with me 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 dropped across it 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 is it going to go this direction or the other. as an investor, my job is a prudent 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 sort of have to come are analyte test compartmentalize it -- compartmentalize it and have to push it aside. 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 prints 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." the first question to you guys -- the next move from the fed, a rate hike or rate cut? lisa: hike. mary: hike. tom: cut. jonathan: interesting. treasury curve positioning. what is your position? steepener or flattener. lisa: initially steepener, later flattener. 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. from new york, that does it for us. we will see you next friday at 1:00 p.m. new york time. for our audience worldwide, this was "bloomberg real yield." this is bloomberg tv. ♪

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alix: oil rallies over 20% from december lows, and saudi arabia vows to export less. is the worst finally over? pg&e's potential demise. the utility reports bankruptcy and gas companies avoiding business with the company. big oil, banks, and traders launch a block trade platform. ♪ alix: i'm alex steele and welcome to bloomberg "commodities edge," 30 minutes focused on companies, fiscal assets, and trading with the smartest voices in the business.