Wall Street Week - Full Show 07/07/2023
Different summer holidays. Secretary Yellen goes to Beijing. OPEC goes to Vienna and the Fed stays home to ponder those jobs numbers. This is Bloomberg Wall Street Week. I'm David Westin. This week's special contributor Larry Summers on those jobs numbers and what they tell us about where long term rates are headed. Credit expert Poornima Puri of piece on the continued resilience in the credit markets and whether it will last private credit market continue to grow.
And Colony Capital founder Tom Barrack on investing in the Gulf states and how it led him to a New York courtroom. I thought this is a great opportunity to start chipping at the system from somebody outside of the system. With the 4th of July holiday in the United States and Wimbledon underway in England. It was time this week to focus on summer holidays. The president over in China didn't get much of a summer break from disappointing economic numbers.
The reality is, is that people have given up on the Chinese recovery. China's moving off its old economic growth model, but it hasn't moved comfortably into what's next. Even as Beijing welcomed Treasury Secretary Yellen for a visit to try to keep the conversation going, it's very important that this president calls for more regular channels of communication between our two countries. OPEC members started their July in Vienna with Saudi Arabia kicking things off by extending its unilateral oil production limits. We had to do it because there was
another ask for the market, a more immediate expectations of the market that the Opec+ would meet. While Swedish Prime Minister Ulf Christensen travelled to Washington for talks with President Biden, including on his country's admission to NAITO. But with all the traveling around, it was good to know that the Federal Reserve remained on the job in Washington. As we got minutes from its most recent rate meetings, which showed that they weren't entirely on the same page last month about whether they should pause the idea of slowing down the pace of rate increases and continue to slow the pace rate. Pace of rate increases make sense, and I think more restrictive monetary policy will be needed to achieve the FOMC goals of stable prices.
Then at the end of the week we got the jobs numbers for June with a little something for everyone. The US added 209,000 new jobs less than the month before and less than anticipated. But still the unemployment number still went down by a 10th to 3.6% and wage
growth accelerated to an annual pace of 4.4%. The equity markets, well, they weren't really sure what to make of it all, with the S&P down over 1%, but still ending at 4398 and is well above the Bloomberg LS media estimate of 4100 for the year end, while the Nasdaq gave up almost 1%. But the real action this week, the real action was over in the bond market where the yield on the two year went above 5% on Thursday, settling down a bit on Friday to close at 3.4.933, while the ten year added 22 basis points to stay above 4% at 4.058. Take us through the holiday shortened week in the markets. We welcome back now Dave Bianco.
He is chief investment strategist at us. Thanks for coming back with us, Dave. Great to have you here. So give us your sense of what the markets did this week. As I said, the equity markets weren't quite sure about it, but boy, the bond market really reacted. What are the jobs numbers tell us about today's Jobs Friday and leading up to it during the week? There are other indicators for the jobs market suggesting that the jobs market still very healthy and a lot of job creation still occurring, particularly at services. So the jobs report was a little softer than the bond market feared.
But you have to realize the bond market was really fearful of a super strong jobs report that would make the Fed have to do more than one or two hikes from here. And the jobs report, when it came in, we saw a couple of things. One, the two year yield sorry, the two year yield fell below 5%, but the ten year yield rose above 4% and it stayed above 4%. Today. I think the action on the ten year yield is the really interesting action this week. Well, are we through are we getting to a breakthrough on bonds here? Basically, are we breaking through to new levels in the ten year and for that matter, to us? The interesting question is, are we walking into a new norm and is that new norm the old norm from ten, 20 years ago? I think what's happening, particularly on the ten year yield being over 4%, is that the bond market is starting to run out of patience for the Fed to win this inflation war.
Inflation is coming down, but it's coming down too slowly because it's been two years now that inflation has been well above the Fed's target. And if it doesn't come down quicker, I think the bond market's going to lose its patience. And if you look at things like the ten year break even versus the PC core numbers, there's a very substantial difference now that there hasn't been historically. And one of those, I guess, has to come down or come up. That's right. So when you look at ten year Treasury
yields at about 4%, the break even or essentially the inflation expectation embedded in that 4% yield is about a two and a quarter percent break. Even inflation expectation, as we call it. So the essentially the long term bond market has been saying it believes the Fed that the Fed is going to get inflation back to its 2% target, but eventually is not a good enough. I think the bond markets at this stage were saying you need to move faster because if we have to reassess the risk of another inflation outbreak and you take more than a year or two to solve the problem, it takes you two, three or more years to get back to target. The bond market's going to have to reprice its inflation expectation and risk premium. As a student of the markets, what is
your best sense of how long the Fed has? If I can put it that way, we're going to get CPI data next week. We're going to see other data coming in. Most of us expect that there's going to be a 25 basis point increase in July. Right. The question is what happens in
September? What happens after September? How long does the Fed have? So now we're going into the back half of 2023. And the first two years were the period of time where the bond market is willing to give the Fed a couple of passes. But now, if inflation doesn't get down faster, I don't think the Fed will be forgiven by the bond market over the long term. I think what you'll have is that the 4% ten year Treasury yield and perhaps even higher than that stays there even as the economy continues to slow because the bond market wants compensation for this elevated inflation risk in this decade that we're in, if in fact, we're baking in higher levels for the ten year, let's just stay on the ten year here. What does that mean for the equity markets? Because there's a discount factor here and typically equity valuations go down and particularly in some of the growth stocks such as tech, which has been doing pretty well. Well, this week is about interest rates and we'll continue to watch interest rates over the rest of the year. Next week we get some more reports on
earnings season. I think earnings will be about $55 in the quarter or $220 for this year. The S&P is trading at 20 times this year's earnings estimate. And tech the tech sector is trading at 30 times this year's. Earnings estimate. I the higher interest rates go, the stronger the earnings growth and real earnings growth that needs to be generated by the S&P and the tech sector to justify these valuations. The valuations are very demanding and
they're not being helped by these interest rates. Okay. So let's assume for the moment that earnings actually measure up and actually support those valuations. Where is it going to come from? Is that is that from price equity ratios? Is that from top line growth? Where are we going to find it? Well, most of the top line growth that we're seeing is really just inflation. And basically the same thing's occurring
at earnings. And I do expect $55 of earnings for the second quarter, which would be down a few percent from last year. But earnings at the S&P have been about $55 per share on a seasonally adjusted basis for the past two years. So earnings have been flat since late 2021. Where's the earnings growth going to come from? Well, that's why the whole market is just overly counting on tech to make up for what's likely anemic earnings growth everywhere else. Tech and particularly some big tech has really been dragging the market average up without a doubt.
That's right. This tech come down or does the rest of the worker catch up? Right. I believe that market, the tech sector is due for a correction. I don't know if it's in the coming days or weeks, but I think over the course of the rest of the year that the tech sector will correct by about 10%.
And for those who are in the debate about will the rest of the market catch up to tackle that, bring the market to even new highs for the year? I doubt it. I think in order to be bullish on the market, you need to believe that tech goes even higher. I don't think it's likely at the rest of the market will drive the overall market higher. If tech doesn't climb higher itself. I'm going to say this I may save the decade in terms of productivity and decent economic growth, but I don't think A.I. is going to save the really weak earnings growth I see for the S&P for the rest of the year. What about government investment? Because we have Biden nomics now, Vice President Biden calls it.
It does a fair amount of investment coming in. Industrial policy exactly right as we had in Japan in the eighties. Is that likely to kick in to really help drive growth and productivity? And if so, how long does it take? Well, that's that will take time, but we'll find out, too, what returns on investment and what productivity we get out of that over time. But in the meantime, we do see investment and manufacturing capacity in the United States, but manufacturing output has been weak and we are still in this manufacturing recession.
It's all on the service side of the economy that's booming right this moment. Dave, it's always a treat to have you with us. Thank you so much. That's David Bianco of DWC. Coming up, our special contributor Larry Summers on what the jobs numbers tell us about the strength of the economy and where long term interest rates are headed.
That's next on Wall Street Week on Bloomberg. This is Wall Street Week. I'm David West, and we're delighted to now have to have our special coverage, Larry Summers of Harvard, to help take us through the jobs numbers and other eco numbers, what they told us this week. Larry, great to have you back with us. What did you make of the jobs numbers? And by the way, there were other eco numbers as well this week. David, these are hot numbers. The rate of job creation is twice as great as the growth in the number of adults. In an economy that's already overheated. That's not consistent with bringing inflation down to its target level.
And you see that in the wage data, which is pointing to inflation way above the Fed's target. We've got a low unemployment rate at 3.6%. And if you look at any of the other labor market indicators that we got this week, the quit rate, the level of vacancies, the layoff rate, the insured unemployment data, all of that based on past patterns is suggesting it even tighter unemployment rate than the 3.6%. So I think we've got an economy that is currently very strong, not sustainably strong in terms of the rate of job creation.
And not very surprisingly, given that strength, we continue to have inflation and indicators of forward inflation well above target. So I think the market is right to judge that. Once again, the Fed has underestimated inflation for basically the eighth quarter in a row. They've been surprised on what's happened to inflation and because they're surprised on what's happening with inflation and the strength of the economy, they're going to be surprised by what they have to do to interest rates. And so I think you've seen an appropriate adjustment in medium term interest rates to this reality. My best guess is that you're going to see further adjustment as the data continues to come in.
But I think it's a mistake to be distracted by the Wiggles. Yes. The ADP number yesterday was super duper strong and today's number was not nearly as strong as the ADP number. But if you step back to the bigger picture, nobody thinks we can continue indefinitely to create jobs twice as fast as the adult population grows. And that means we're having tighter and tighter labor markets.
And that means an inflationary picture. And the Fed's going to have to respond to that. Larry, you were one of the very first, maybe the very first to identify this risk here on Wall Street, but also in your pieces for The Washington Post. I guess the two questions that occur to anyone is, number one, what's it going to take for the Fed to get really inflation under control, number one? And number two is why has it taken so long? It's taken so long because we started out so late, and given how late we started, we didn't move sufficiently because we believed mistakenly that the neutral interest rate was still very low and we believed mistakenly that raising interest rates would have large impacts on the economy that were greater than the impacts of interest rates in the current structure. And we haven't really recognised that.
It's a basic feature of the inflation process that while you get transitory fluctuations, you don't stop at underlying wage inflation without having a significant slowdown in economic activity. And since we haven't yet had a significant slowdown in economic activity, it shouldn't be surprising that we've still got inflation well above target. Nor should anybody take comfort from the fact that the components of inflation that everybody recognized were transitory. The fact that they've come down in some cases even going into reverse, is better than if they hadn't much better than if they hadn't. But nobody ever thought we were an underlying 8% inflation country when we were having 8% inflation.
So the fact that the rate has come down shouldn't be confused with saying that we can be confident that we're on a path of this all being okay. And certainly not with saying that we're can be we can be confident that we're on a path for this all being okay without the Fed doing more to raise rates. So anything's possible in all of these judgments, David, or statistical. Maybe we'll get a big productivity boom out of I very quickly, though, I think that's unlikely. Maybe the inflation process will behave very differently than it has in the past. But I think the best guess has to be that the Fed's going to have to raise rates more, that if the Fed wants to see inflation get back to its target, it's going to have to raise rates enough that at some point the economy suffers a downturn. And I've said it many times on your show
before. But I don't see anything that changes my mind from the view that soft landings represent the triumph of hope over experience. Larry, I want to turn to a different subject here that you wrote about in The Washington Post this week, and that is the so-called affirmative action decision coming out of the Supreme Court that says you not only are an esteemed economist, you not only were secretary of Treasury, you also ran Harvard. And for some time you really lay out there how difficult this issue is, that it's a broader issue. It's an important issue, but a broader issue than simply race.
Look, I wish the Supreme Court hadn't acted. I wish it had let the world continue on the path that it was. Let private institutions make their choices about how they're going to pursue fairness as they see it. But right now, there's a critical choice
that leading universities face. One option is that they can gerrymander the in place the admissions criteria and change just exactly how they do it and encourage people to put certain sentences in their essays and do away with standardized tests that have a lot of information and fight to try to keep the exactly same percentages of racial groups where they are. That's one approach. I think if they do that, they will be
increasingly resented by the broad public. They will diminish the intellectual quality of their classes. And in fact, they will have done very little to promote social justice. The alternative path is that they step back and they recognize that really the important test for them in this era is their overall contribution to opportunity in America. And if that's what they want to maximize, it'll be a very different path. No more legacy admissions, no more special admissions for people who've been coached extensively to be good at aristocratic sports. Deciding to expand their class sizes so
that more can benefit from what they bring and not defining their greatness by just how exclusive they are using the power of distance education for their education to be defined by more than what happens in the fall and spring semester on their campus. But training teachers during the summer training able students with computers. And crucially, crucially, turning their energy to strengthening what happens in our public schools across the country. All right. Look, David, only about one and a half percent of the students who swore in the top ranges of the S.A.T. are African-American. Yep. Until we fix that, no durable solution to these problems. That needs to be a crucial part of the
mission of our elite schools. So terribly important. So profound. Thank you so much. Great to have you back with us. That's our special country, Larry
Summers. Coming up, Secretary Yellen is visiting a very different China from the one President Reagan went to nearly 40 years ago. We'll compare the Middle Kingdom then with the Middle Kingdom now. That's coming up next on Wall Street Week on Bloomberg.
This is Wall Street Week. I'm David Westin. President Reagan traveled to China for the first time almost 40 years ago when Louis Rukeyser talked about a very different Chinese economy and a very different level of U.S. debt. Meanwhile, the Republicans were glorying in the marvelous media coverage of Ronald Reagan's smiling trip to communist China, a voyage that might have seemed as unlikely four years ago as, say, a $200 billion deficit. There is, at least this time around, a little less of the euphoria in the US business community that prevailed when that other virulent anti-communist Richard Nixon went to China in 1972. To take us through just how far the Chinese economy has come since President Reagan's visit in 1994. Here's Bloomberg International economics and policy correspondent Michael McKee.
As an old movie actor, Ronald Reagan knew that in politics, as in show business, timing is everything. After presiding over two of the deepest recessions in American history, by 1984, President Reagan was running for re-election and anxious to frame the morning in America again economy. He found a willing partner in China's Deng Xiaoping done presiding over an economy devastated by the Cultural Revolution, was opening up the country to foreign investment and trade. Music to Reagan's ears.
One thing China had in abundance was cheap labor. It became a manufacturing powerhouse and export led growth. Turbocharge the economy on a dollar basis. It is now the second largest in the world right behind the U.S.. And Reagan helped lifting trade sanctions on China. That had an important impact on the U.S. as well.
From Reagan's time through Obama's presidency, Americans saw inflation and interest rates fall to almost nothing. They also saw millions of factory jobs disappear and a hollowing out of American manufacturing that's created big tensions between the Chinese and the U.S., a trade war and sanctions. Again, China has also run into the law of big numbers. It cannot continue to keep growing at the same pace.
Indeed, exports jumped post-pandemic but are now falling off. The post-pandemic economy is, by China's standards, sputtering and with it the US-China relationship. Janet Yellen isn't likely to get the same reception Reagan found almost 40 years ago. Thanks to Bloomberg's Michael McKee. Coming up, the oil and gas riches of the Gulf states have given them enormous funds to invest in the West, but they're also attracting substantial investments from the West. Tom Barrack has been an active player in the region for decades.
He'll tell us what he has learned. If we're not there to hand in glove to fix the rest of the things they need, China will be there. This is Wall Street week on Bloomberg. The Gulf States since oil was first discovered in Saudi Arabia in 1938, the region has dominated the world of geopolitics because of its rich deposits of oil and gas. And this week, Saudi Arabia once again sought to assert its power by extending production limits. We needed to head on, reach out to these issues, attend to them, and go for what we think would be the right recipe to attend to this market situation.
But for investors, it's not just a question of what Saudi Arabia and the UAE will mean for the price of oil or Qatar for natural gas, but also what investments they'll make with all those revenues. Secondly, what we see in the Gulf is a remarkable determination to pursue reforms. There are some who think that the fortunes of the Gulf are oil and gas. In fact, the fortune of the Gulf is decisiveness in putting the economy on long term sustainable path. Investments like the kingdom's public investment fund makers rivian and lucid. They're not really just about EVs. They're about the whole ecosystem that comes with EVs and technology.
We're making bets for the future and for the green future as well for its live golf venture being merged with the PGA. I think getting together is the best thing for golf. This fight that was going on and the lawsuits that were raging in one side, the golfers from the left and, you know, taking shots at the PGA and vice versa. That's not constructive for the game.
The UAE is one of the largest shareholders of the Carlyle Group and recently agreed to acquire a 70% equity stake in Fortress from SoftBank. Mubadala will own 70% of Fortress equity, while Fortress Management will hold a 30% equity interest. But the investment funds don't only flow from the Gulf states to the West. Saudi Arabia looks to raise some of the
$500 billion it needs to build neom from Western investments. We had really significant interest from the market. 23 financial institutions participated in the close of the green hydrogen, and according to U.N. statistics, the UAE is the largest
recipient of foreign direct investment in West Asia. And to take us through the possibilities of investing in the Gulf. We welcome now someone who has spent his career there.
He is Tom Barrack, the founder of Colony Capital. Tom, great to have you here. Thank you so much for being on Wall Street week. Great to be with you, David. As I say, you really spent your career in and around the Gulf.
Give us an investors perspective right now in the Gulf. Where are there opportunities? But also were there perils? So it's always been a misunderstood era, right? Because it's tribes and flags when we talk about the Gulf. There's 54 countries really that make up kind of the the consortium of Gulf countries, four big ones. But if you think about it, the the
resource curse. So from 1960 on, the discovery of oil and gas in these small populations led them and really a 70 year period to dominate the investable world. So from producing oil and gas, being the beneficiary of receiving those dollars up until now to reinvest in them and saying we've got to diversify, we have growing populations, we're now becoming more astute and aligned in the international economy. How do we diversify? What do we diversify into? And remember, the constituency is it's not a pension fund.
So their investable universe of the big sovereign wealth funds, which by the way, are the largest investors in the world today. Adia Mubadala PIF KKR are multi-thousand investment groups investing in all asset classes around the world. So the goal at the moment is for them to diversify outside investments and at the same time start moving their own economies and their own young populations to a non resource based economy. And that's the that's the biggest challenge in most of these countries. The royal family directs the politics, and the politics is also driving the business decisions. So you have the same individuals in various positions that are looking at these big themes over long periods of time.
And the constituency is the legacy. It's not for the retirement of individuals. So it's booming. Whenever one invests cross-border, there's political risk involved. How does one assess the political risk in that region? Certainly we've seen it flare up in Saudi Arabia in various ways. How does one assess that and make sure that you're protected from that, possibly affecting your investment slowly and carefully? I'm a great example of that. So I think for all for all business men, soft diplomacy is is part of the goal that you're trying to reach long line relationships, understanding the geopolitical risks of where you are, the rule of law, the cultural orientation. We've always talked about
this cultural sixth sense that foreign policy has so much to do with it, especially in this region. It's a dangerous place. Why is it dangerous? Because all of these countries have been our allies really from the beginning of World War One. They, as a group, are the largest buyers of U.S. military equipment.
Saudi Arabia, Qatar, Abu Dhabi are our largest foreign buyers of US military, and we have military agreements with all of them. But foreign policy ebbs and flows and that part of the region, and as we've seen now with sanctions, for instance, and Russia and the threat of sanctions elsewhere, the rule of law sometimes is confusing to them as to the difference between foreign policy and military policy, business practice, business diplomacy. As the United States returns to kind of a globalization mode, which we can talk to more, which is what's happening, I'm not in favor of that, by the way, but it is certainly happening.
You know, this idea of let's make America great, I was always an enthusiast, said, why don't we let's make America great in the world better. We're just missing one piece of that. So the geopolitical aspect is so important for the U.S. now, not to give up on that and not to just be there to take money, because if we don't help, if we're not there to hand-in-glove fix the rest of the things they need, China will be there, Russia will be there. They'll fill that void.
The the the dollar. Inconceivable to think that you would be in a petro business and U.S. dollars. But we're really at the verge of that about to happen with the renminbi going to a digital currency. You know any of these things could happen if there's just. A mismatch between
foreign policy thought, military execution and business soft diplomacy. So I think it's it's it's a moving target. And we all need to be cautious and we all need to participate.
And participating in business is the easiest way to solve some of those cross-cultural issues. Tom, you referred to your personal experience and being exposed to some of the risks in what you call soft power with investing. You obviously were indicted on nine counts. You had a seven week, eight week trial in the Eastern District of New York. You were acquitted on all charges, I must say. What did you learn from that experience that would be helpful to others in 2016? Bob Mueller started investigating President Trump for Russia. And.
By the way, I have nothing but respect for Mueller and his team. They did the job they were supposed to do, and they did it elegantly and in the manner in which it was supposed to be done. And during that time hired, he had asked me to testify voluntarily, which which I did. And this was about Russia. But in that process, the Gulf states were starting to. Two surface to surface for interest. Never.
Never for any evil purpose. Never for any attendant purpose. Just saying in this campaign, we don't know who Donald Trump is. Who is Donald Trump? I thought this for me at the time was an incredible opportunity. I mean, you and I have talked before.
I was never really political. Donald had been a friend of mine forever. I thought, this is a great opportunity to start chipping at the system from somebody outside of the system. So what got confused with me was my interaction, which was always business.
As I said, the rulers of all these countries also are the ones making all the business decisions. So the sovereign wealth funds ultimately are governed and ruled by a monarchy. These are monarchies never inappropriate. The big funds idea Mubadala is run by some of the brightest young professionals ever, as is QE, as is never an ounce of of impropriety. And on the heels of the Mueller investigation, some of the prosecutors when they left, go back into their own regimes. By the way, let me just start with
saying people are always asking me, is that at the prosecutors corrupt, are they evil? Did this come from Merrick Garland or is he targeting you? And my answer is absolutely not. Quite apart from your long term relations in the Gulf, you've been a long term real estate investor. Commercial real estate is very much in the news these days. A lot of troubles in some parts of the
commercial real estate business. And it's affected some banks, including First Republic Bank, that you at one point owned, as I recall. And we're on the was on the board of. What did we learn from First Republic Bank. How concerned should we be about broader
problems? What happened to those banks was not a credit problem, not a capital problem. It was a confidence problem. It had never happened before in history. With a click on a phone, you could have $18 billion of withdrawals in an afternoon liquidity for those deposits. Just a simple way, I think for for all of us to look at it is in banking makes no sense. If you take short term deposits and you match it with long term loans. What you're putting on the balance sheet
along with the requirement, the government saying you need to buy long term bonds at fixed rates. It has the lowest capital charge, but those are held to maturity. You don't have to mark those to market and then you have assets for sale and you and you have loans, but your main source of funding is deposits. So during the zero interest rates, huge
companies were not concerned with putting their deposits and getting yield because there was no yield. So they did four services. So a bank like First Republic Bank supplied extraordinary service along with zero credit risk that banks credit loss ratio was 0.003 over 30 years. So it wasn't it wasn't a credit crisis. Tom, thank you so much for being on Wall Street. We really appreciate it. That's Tom Barrett. He's the founder of Colony Capital. Coming up. People keep waiting for real cracks in
credit. Poornima Puri of UPS tells us whether they are coming. You've got friends that are actually not that wide and perhaps not representative of that and the risk and the corporate credit market. This is Wall Street week on Bloomberg. This is Wall Street Week. I'm David Westin. Solid jobs numbers out this week underscored the likelihood of another Fed rate hike later this month, with more possible in the fall posing further challenges for the credit markets. We welcome now a credit expert. She's Purnima Puri, governing partner of HP as investment partners.
So, Purnima, thank you so much for joining us. Let's start with that question of monetary policy. People are expecting the Fed to keep hiking, at least for a while. What does that mean for the credit markets you deal with? Yeah. So we we generally deal with levered credit and I think that we are of the view that there are likely to be one more hike, maybe there's two more hikes. And I think that that in general we're
sort of closer to the end of some hikes than obviously we are to the beginning. So I think we're coming to the tail end of the hike cycle and and people are starting to now look at 24 and, you know, when when is the Fed going to cut and what's going to what what are that what are the indicators they're looking at that would make them cut? So when I checked it this morning on the Bloomberg, the spread for high yields, just thick, high yield was something like above 450 basis points. Where do you expect that to be going? Is that where we end up or is that going to continue to rise? And so when. Yeah, so I think you got a big push and pull, which is that base rates are pretty high and north of 5% and, and then you've got spreads that are actually not that wide and perhaps not representative of the of the risk in the corporate credit market. And I would actually say that's true for investment grade as well.
I think investment grade is 140 over plus or minus. And now yields in the sort of low to mid four hundreds over. So I think our view is credit spreads are not indicative of risk necessarily. Yields are all in are reasonably wide. So that's the that's the trick.
And I would suspect that you'll see spreads go a little wider, primarily because we do think you're going to continue to see some margin deterioration for levered credit, number one. And number two, we do think we're in a in a bit of a longer sort of higher for a longer rate environment which which will pressure cash flows as well for corporates. When I take us through how it works and credit the mechanics of it, because I've seen some reports that there may be a delayed response because some companies and this is both for investment grade but also for high yield or leveraged loans locked in rates, you know, at a lower rate that's coming due in the next couple of years. I'm told a fair amount of money's coming due and it may be a little difficult to get it refinanced. It acceptable levels. Yes, I'd sort of take that into two pieces.
So in general, you got a bunch of fixed rate bonds, whether that be investment grade or high yield bonds that were issued at a different moment in time in the market when the five year and the ten year were significantly lower. Those fixed rate bonds are a real asset right now in the current rate environment. I think on the on the second ED spectrum, you've got the loan market, which is a large, large market, which is all anchored on a base rate plus a spread. And so as that base rates move from 1% to north of 5%, that's hurt businesses a lot. So if you think about sort of corporate balance sheets, you know, an incremental 400 basis points of cost of leverage on their debt stack that is loan related has been pretty painful as we look toward refinancing, has the bargaining power shifted between the lender and the borrower? There was a report actually just this week that KKR had to make concessions to lenders to refinance a deal on a Dutch food company without talking about the specifics of that. Are you seeing that phenomenon or do you expect it more generally? We had Covenant lite. Maybe we were going away from that.
Yeah. I'd also answer that in two ways. So. So the first is that it depends. The answer is through some of these bigger, well known businesses that are large, large corporate capital structures, there are some covenants and stuff that are getting put in place when they're being issued through the liquid markets. But I wouldn't say there's been a huge sea change. It's gotten better. But I wouldn't say there's tons of covenants.
I think the documentation structures have certainly gotten better, though. So I think that's one to is the loan and high yield space. The issuance numbers have been very endemic this year. So there hasn't actually been a ton of net new issuance. The third thing I would say is where where there has been, I'm not sure that it's been a change or there's been continued more balanced power between the issuer and the provider of capital is in the private credit markets, which has been open for business.
Unlike the liquid markets and the private credit markets tend to. Be able to defend better structures and better documentation in general. And in today's environment, when the liquid markets or the capital markets, if you will, are are not sort of wide open for issuers. The private credit providers have been able to step into their shoes and in many instances in pretty large deals. One of the things we have read about is a shift away from banks and toward private credit as the banks have to step back, particularly in light of what happened in March. People are stepping back. Are you seeing a substantial shift over
to private credit from the banks and other sources? Yeah. I mean, I would say that shift has happened already over the last several years. And the private credit market is actually, you know, on par or slightly in excess of the size of the of the loan, the syndicated loan market today, if you believe sort of what we see in terms of estimates that growth will likely continue to increase. And I think one of the big questions
around how quickly the increase and where it will will end up landing is is a little bit a function of how tight credit conditions continue to get and then how long they stay there because lending standards have tightened up. You know, it didn't get tight, as I think people had estimated the numbers to be significantly more impactful after the March. Regional bank failures. I'm not sure we've seen the full impact of it yet. So I think that's a that's a that's a remaining question. But I do think that you'll see that private credit market continue to grow. And and and it's it's exceeded the size
of the syndicated market. And finally, part of what you mentioned, anemic issuance, particularly in high yield. We haven't seen a lot of M&A, certainly not the way we had in the past.
Is that coming back because the traditional as I understand it, a lot of the high yield is coming out of private equity, doing buyouts. Yeah. I think we're seeing I think eventually yes is the answer. I don't think the capital markets are
sort of, quote unquote open for business yet. I think as you continue to see volatility subside, you will likely see the M&A pipeline open up a little bit. But as we sit here today, there's a lot of I think you alluded to this earlier in one of your questions, but there's a lot of digesting that's still happening in terms of corporate balance sheets and cash flows. And and and we haven't quite gotten to
the to the very end of it yet, so. So I do think it'll come back. But I think you also have to sort of see value volatility continue to be sustained in a bit of a lower level. Okay. Thank you so much for being on Wall Street. We really appreciate. That's Putnam Macquarie. She's at HP Investment Partners. Coming up, fighting inflation with everything we've got, including our beer.
That's next on Wall Street week on Bloomberg. The markets come down in Europe from the financial centers of the world. Bloomberg Markets European close with Guy Johnson in london and Alix Steel in new york. Real time numbers.
Real time analysis weekdays. Finally, one more thought. Looking for more ways to skin the inflation cat. Inflation has been the number one topic for investors and economists and lawmakers for much of the last two years, with a broad consensus that we needed higher interest rates to get things back under control. No one's pulling harder for the Fed to strike this balance and get it right. That may, but I think it's not going to
be an easy one. Most people thought the Fed waited too long. I am confident that they understand the problem correctly now. The wishful thinking is all gone.
The idea that it's transitory is gone. But then it was off to the races with 500 basis points of hikes in the last 16 months. And still inflation, particularly core inflation, remains stubbornly high.
Inflation pressures continue to run high. In the process of getting inflation back down to 2%. Has a long way to go, with some Fed officials saying they need to keep going. A decision to hold our policy rate
constant at a coming meeting should not be interpreted to mean that we have reached the peak rate for the cycle, while others aren't so sure. The median committee participant believes the FOMC needs to do more to get inflation back to our target. And here I have to confess, I do not fully share this view. So maybe it's time we started looking for some new ways to skin the inflation. Cat Hotel workers in Los Angeles had an idea this week. They walked out for higher pay. But wait a minute. That might help them, but would just
make it worse for the rest of us. Right? A better plan is to cut some prices, which is what Italians apparently managed by threatening to go on a pasta strike leading to the price of spaghetti and fusilli and linguine. To suddenly turn around one. Once the wheat is purchased by the pasta producers, the transformation and the sale come at a later stage, depending on the kind of pasta, several months pasta. Therefore, there must be no surprise if the durum wheat price decreases and the pasta price is still increasing. Or better yet, cut the price of gasoline. The Sheets Convenience stores based in Pennsylvania decided to honor the nation's birthday this week by reducing the price of gas at their pumps to just $1 and 77.6 cents a gallon.
But that was just for the 4th of July itself. And then there's our favorite way to beat inflation, the one chosen by Connecticut Governor Ned Lamont. As of this month, he cut the state tax on beer, reducing it by almost 17%, meaning a barrel beer, which as we all know is 31 gallons now costs $6. That's down from the $7.20 it cost just last month. The governor says it is a way to support locally owned small businesses. And as we all know, when we're really hurting, a beer may just help. Would you like a beer?
I'll get you a beer. I'll be all right. That does it for this episode of Wall Street Week. I'm David Westin. This is Bloomberg. See you next week.
2023-07-14 04:30
