♪ jonathan: from new york city, "bloomberg real yield" starts right now. looking ahead to the fed's next meeting as the ecb stands its ground. china begins to head the other way. we begin with a big issue -- divided views on the fed's next move. >> people are being aggressive, but the fed is going to have to move. >> deliver the balance sheet reduction. >> could we say something a little bit more aggressive?

>> in march, it is go time. >> even a 50 basis point move coming up -- >> 50 basis point hike in march. >> way to aggressive. >> doesn't seem like the type of action the side would take. >> more rate hikes on the table. >> two to three. >> if they make a policy mistake is because they move too slowly. >> it is frankly too late for the fed to engineer a soft landing. jonathan: joining us now to discuss is jp morgan's -- and blackrock's bob miller. the expectations for this year is so wide. what's your best case now? >> so we do expect the fed is on track to start raising rates in march. we also think that they are going to use the balance sheet in a way that was different than in prior cycles. we think they feel that the balance sheet is this escape

door for them. because if they hike too fast and they impart the yield curve, they start shortening the cycle. instead what they are doing as they are looking at running down the balance sheet at a fairly fast pace. we think about $50 billion per month in treasury. starting in june or july. then they use that to tighten financial conditions. get real yields higher and hopefully do it in a way that doesn't materially disrupt the recovery that's been well entrenched over the last two years. jonathan: that's the hope. you may it some very simple and easy. we know it's not going to be. bob miller, your best case on the balance sheet. that's the interesting component and all of this. how do you discount some things we have not done in the size before? -- this size before? >> i think it is precisely the right question, in terms of what could go right and what could go wrong? the market's reasonably placed for rate hikes.

our view is this -- that they can proceed with balance sheet runoff. think about since the balance sheet tool has been introduced, during the financial crisis, a little over a decade ago. it's basically been used to the liver monetary policy objectives six times. the three times with her balance sheet was used with specified parameters, with explicit monthly targets and a number of months and the total amount that would be done, all three of those episodes qe 1, 2, and operation twist ended without elevated volatility in markets. the other uses of the tool, the quantitative tightening -- sorry, qe3 was open-ended. the quantitative tightening example in 2017 2018 was open-ended and ended badly. this time the quantitative easing post-covid -- open-ended

, didn't end well. our recommendation is simply this -- do balance sheet runoff in specified increments. i wouldn't disagree -- $75 billion for a month for 18 months. $100 billion a month for 12 months. get somewhere in that total number which will effectively drain the rrp -- currently sitting a bit north of that. just drained that, stop for a minute, observe what's going on and see what you need -- see if you need to do more, but don't do the open-ended qe exercise, it's not going to end well. jonathan: do you think it perhaps replaces or complements rate hikes, what bob just laid out for us? >> that's a great question. we think that's probably a go in july.

$100 billion a month. to put that number in context, the last cycle, the fed started at $10 billion a month and ramped it up to $50 a month. the number is substantially bigger this time around. some of that reflects the size of the balance sheet. it's bigger. on the positive side, relative to the last cycle, the market seems to be in a better shape today -- particularly the fact that the fed has a reverse facilities that should allow for the withdrawal of liquidity to have a base. there are a lot of lessons to be learned. one of them as that maybe the market was not in the shape that was good enough to withstand a base of -- the balance sheet runoff. this time around i think we are in better shape. for risk assets, i think you always have to think about the drivers in the backdrop. the rule of thumb that is generally used is that a balance

sheet reduction that is equivalent to 1% of nominal gdp would translate into two basis points in longer-term yields of course. there is significant uncertainty around that number. more importantly i think what matters is the composition of the move. what we have seen the last two weeks is a selloff in rates that's been entirely driven by real yields. if that repeats itself over time, you could create a little bit of an environment for risk assets. jonathan: how far -- the fed rate as well. take a listen to what bob had to say on how far the fed could push interest rates. >> it is frankly too late for the fed to engineer a soft landing. they now have to focus on getting inflation back down. we are going to see a fed funds rate that's going to get to 3% minimum and the cycle. by the way, it's not so

preposterous to get to that level. we got 2.5% back in 2018. jonathan: can we get to 3% without something breaking, bob miller? >> tell me what's going on with the balance sheet. right? i think you have to view the combination of those tools. so if there is no balance sheet runoff, then 3% seems a bit high, but it's probably a distribution of outcomes. if the balance sheet is running down at $100 billion a month, then i think 3% is a lot. it is interesting that, you know, four to six months ago, a majority of the marketplace was dismissive about inflation pressures and but the fed was going to be on hold for a very long time. and now, sentiment has swung wildly in the other direction. i think they are going to hike four times this year and get the

funds rate to 250, maybe 2%. if the balance sheet is running out for a while, they will not need to hammer the economy. i disagree with that point of view. inflation is not -- you are going to have to have the same degree of price increases to keep inflation up here. it's entirely plausible we are going to have to reset the price level in the economy. and inflation -- the rate of inflation decelerates fairly aggressively over the next two years. jonathan: that could start and spring -- in spring. cafe, give me your view on that, can we get to 3% with the balance sheet reduction you described and the funds rate at 3%? >> i think bob brings up a good point in terms of the interaction between balance sheet and the fed funds rate -- it is very untested. we do need to see what is going on in the balance sheet and with inflation. i think there's a fair argument

you are going to see some deceleration in inflation over the next few months, but what i really have my eye on his wages. because that's what we are watching. we are watching -- are we at risk of a price wage spiral? i think at this point, we don't know for certain. we have the eci number next week. if you listen to what chair powell said, that one of his recent congressional testimonies, he revealed the q3 eci numbers was really a turning point for him. it's what made him reassess the amount of tightness in the labor market. and the underlying pressures -- and where the underlying pressures of inflation were going. we have not seen to win a row since 2004. that's what i would be watching to see if the fed can continue to raise rates, beyond the first four-five, which we expect for this year. jonathan: that was the key data

point. not the fact he got a second term. we can come back to that another day. steve says we have seen inflation peak in q1, but until we see that pic, the doves are on the back foot. before we go, i want to finish up with this -- i spoke to someone this morning about the sequence and the timeline compared to the previous decade. the previous cycle. just the runway last time around. they started talking about tapering in 2013. 2015, 2 years later, when the rate hike conversation came. two years after that, we started doing balance sheet reductions -- qt. your thoughts on the fact we are doing all of this and just a couple of months? maybe six? -- in just a couple of months, maybe six? compared to last him around, where we did it over several years? >> you are absolutely right.

last cycle was all about optimal control and doing things in multiple sequences. this time around, it's all happening remarkably. but the fact that it is still buying a significant amount of bonds while at the same time talking about how exam quantitative tightening, etc., that just speaks to this cycle, compared to the previous one, the velocity of the recovery and the moves in the financial markets -- nothing is shy of spectacular. is there a risk things go too fast? absolutely, there's a risk, but i would agree with what bob mentioned earlier, there are two key elements here. things are dependent, and things will depend on where inflation goes. it will probably become the first quarter of the year and then after that, it will decelerate slowly. but we will be on a decelerating path. the question is, what is the equilibrium level? will we settle?

2.2%, if you take the fed's favorite inflation measure. there's a lot of uncertainty. i certainly don't disagree with the concern that things might be moving a bit too fast here. jonathan: thank you. coming up on the program, wall street's biggest banks dominating issuance in the primary market. that conversation, up next. from new york, this is bloomberg. ♪

jonathan: i'm jonathan ferro. this is "bloomberg real yield." we will kick things off with another steady week of issuance.

monthly sales approaching 200 million euros. america's biggest banks driving supply higher, pushing monthly sales closer to estimates. with more than a week remaining in january. the junk bond market heating up following a slow start to the week. pricing for billing dollars thursday alone. the busiest session in three months. back with us are our guests. kathy, i want to start with the credit market. you make a good point. the corporate fundamentals is something you have confidence in. you are to balance that with financial conditions you expect. what do you do in this environment? >> absolutely, that is what we are trying to do, or trying to balance the fact that, despite the fact that we know that central banks are removing accommodation, we don't want to throw all the work that are credit analysts have done totally out the window. we know that corporate fundamentals are strong. we know consumer balance sheets are strong. where we are focused is getting credit exposure, but in ways

that are structured to be protected against higher rates. for instance, bank loans is the perfect example, we have a floating-rate component. if you look at how they performed year to date, just despite the fact that high yields are down about 1.5%. we are up about 50 basis points. out abs, consumer loan abs, we know the consumer is still flushed with cash, 2.5 trillion dollars in excess savings, and that's not going to go away immediately, that's going to go away over time. jonathan: how would you balance that with your exposure to say inflation protection? the story of last year, a lot of people rushed towards getting inflation protection. it seems to me coming into this year, get an exposure to higher interest rates and protection from that as well. if you are going to bet on the success of the fed, do you will

do everything you just said and move away from inflation protection? >> last year was absolutely a great year -- they had massive inflows. you have five times more inflows into tips then you had in the two years prior to the pandemic. and that's what shows financial conditions to be so easy. one thing you haven't spoken about -- we talk about the levels of real yields. it is also about the slope of the real yields curve. that slope is still very steep. meaning that front-end real yields are much more negative than longer and real yields. when financial conditions tightening as a result of the fed removing accommodations, you will see real yield curves start to flatten and negative total returns -- that's not a place that i'd be positioning right now with the fed on the move. jonathan: let's talk about the credit side from your perspective and why you think we will continue to see resiliency

and credit, versus a equities. why is that -- versus say equities. why is that? >> fundamentally, it is hard to make a bearish case. but you have liquidity positions that are at their best level and probably two decades. even growth, you know, even if it slows down, the fact of the matter is you have an economy that is growing above trend, through most of 2022. fundamentally, i think the market is well supported. on the other hand, from a performance or evaluation standpoint, we have to be clear about that, there's very little upside in phone and at these levels, at least on the public side -- and owning credit at these levels, at least on the public side. from a performance standpoint, i would describe 2022 as they year in which we are going to transition the fixed income markets to much lower returns.

certainly in the aftermath of the global financial crisis. where do we go in credit? we think the direction of travel is modestly wider here -- 10, 15 basis points. that just realigns the reality of the cycle that's actually aging and maturing at a rapid pace. if you benchmark that level relative to say the history of the last two decades, it is still reasonably tame. the draft for the cycle is certainly behind us. jonathan: it is realistic, it doesn't sound terrible. when i read research from bank of america this morning which said the federal reserve's hiking interest rates into overvalued equities and overvalued credit, this feels very 2007. when you hear things like that, bob miller, what's your response to it? >> they need to recalibrate policy in an effort to extend the cycle. and so, can the engineer a soft

landing? that is the critical question. i think it is possible. it's not necessarily the most likely outcome. but it's possible. and i go back to the same point all the time. i think it comes down to how aggressive are they with both of their tools? and do they overreact or overdo it this time around, similar to late 2018? or is it a more deliberate path to recalibrate policy, appreciating there are a number of highly unusual factors that work at the moment, related to economic shutdown and related to a pandemic. it is just different this time. i don't think the old rule applies. i think there's a pastor land the plane. -- path to length of the plane. they have a tendency to overdo it in both directions. we are betting at the moment

that the soft landing is a reasonable expectation. but we've got hedges in place, in case the policymakers decide to go a bit more aggressively. jonathan: we are assuming they can fly this plane, and they can land it. you are telling me it is really critical. at the same time, would i have much experience with this. -- we don't have much experience with this. kathy laid out some very big numbers we can see play out in the next 18 months. most of you have agreed. bob, you ended by saying we are taking out some protections -- can you tell me what the protection is? where do you get that protection? >> something u.s. kelsey earlier, we are short real rates. we have been for a while. we have seen the move in the past couple of weeks. i think you can win a couple of different ways. i can see rules continuing --

reals continuing to move back toward zero, through modestly narrower breakevens, at the curve especially, or modestly higher nominal rates. any combination of those two things will continue to push reals higher in yield. our expectation is simply that with a fed that is going to be raising rates and has signaled they intend to allow balance sheet runoff, potentially had a fairly aggressive clip, the combination of those two things definitionally will lead to higher yields. jonathan: bob miller, sticking with us. from new york city come up next, the final spread. the week ahead, featuring the big fed decision. this is bloomberg. ♪

jonathan: i'm jonathan ferro. this is "bloomberg real yield." time now for the final spread. coming up, economic data on top. pmi's coming out on monday. followed by consumer confidence and u.s. gdp figures. the main event coming up once a -- the fed rate decision. -- wednesday, the fed rate decision. let's get to the rapidfire around with our guests. let's start with this one. i'm going to throw question that you. how many hikes this year, kelsey? >> four. >> lofti. >> four. jonathan: bob. >> four. jonathan: does the balance you get announced in march or later in the summer? >> july. >> later in the summer. >> may. jonathan: ok. final question for the three of you. the ecb is trying to fit this

one out. they managed to do that last time around. we have a full fed hiking cycle. the ecb did nothing. do you think the ecb can set out this fed rate hiking cycle -- sit out this fed rate hiking cycle this time around? bob. >> i don't know. [laughter] >> it is the perfect question. >> yes, i do. jonathan: kelsey? >> no, they can't set up the cycle and they may raise rates as soon as december. jonathan: wow, interesting call. thank you all. from new york city, this was "bloomberg real yield." this is bloomberg. tv -- this is bloomberg tv. ♪

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>> i'm mark crumpton with first word news.

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