Bloomberg Wall Street Week - December 2nd, 2022

Sam's l Sharmon and founder of Equity Group Investment. In Bloomberg Wall Street Week with David Weston from Bloomberg Radio Easy does it whether it's fed rate hikes or China letting up on code restrictions or steering clear of a rail strip. This is Bloomberg Wall Street Week. I'm David Weston, this week's special contributor to Larry Summers on the jobs numbers and Chair Poll's take on inflation. Mike Arroghetti of

Aery's Management on the remarkable growth in private credit. Private credit has ended out perform when rates are going up. And Tom montag And and Finucan on their new Tea PG venture into the world of carbon credits. We saw an opportunity to improve the whole market. It was a week of searching for the happy medium, as China began the week in an uproar over COVID restrictions. Put in perspective by former US Ambassador to China, Gary Locke, this

is clearly the worst sense genumen square. But things ended the week a bit more calm for China after authorities signaled some easing in the COVID policy, as urged by World Bank President David Melpass I think they could use a recalibration more targeting of their of their lockdowns. We started the week with a looming rail strike, but President Biden and Congress sought to calm things down by stepping

in and imposing a deal on the parties. The US is passing the bill to avert the strike by those freight rail workers, and consumers seemed to be seeking their own happy medium as they started their holiday shopping. It was kind of muted Black Friday. You know. It was solid customer traffic overall, but not strong, all of which brought us to FED Chair Powell, who struck a balance, or at least tried to, between raising rates too much

and not raising them enough. We need to raise interest rates to a level that is sufficiently restrictive to return inflation to two. There's considerable uncertainty about what rate will be sufficient. But then the US job numbers came in on Friday, and there was nothing modern about those two sixty three thousand jobs created November, and employers are paying more for every one of them, with average hourly wages up a whopping point three point six percent month over month,

and that's five point up year over year. The markets took a look at all the and didn't like it one bit, that's at least at first, But by the end of the day on Friday had settled back down and overall the SP five gained over one for the week and the NAZAC was up over two percent, while the yield on the ten year fell to under three point five percent for the week after starting out at

nearly three point seven. Here to help us sort through this all, welcome now, Greg Peters back to Wall Street week co ce io for fixed income at PIGIM, and Christina Hooper welcome back from Investco. She's chief marketing strategis there. So Christine, let me start with you. I think the J Paul was trying to calm things down, but I'm not sure he accomplished that. He did not accomplish that,

but that's the market's fault, not his fault. I think he was very clear, uh in telling us what we already knew, which is that the FETE is likely to downshift a fifty basis points in December, but the terminal rate is very unclear and we have a ways to go in terms of taming inflation. Really the only positive was around housing and talking about the rolling over there.

But other than that, I think he was a straight shooter about setting the table for what uncertainty there is in terms of where the terminal rate is and where the FED pauses. But Greg he also set the table for being really concerned about wage inflation because he talked about the really dislocation partaken on the Jolts numbers, and then those numbers came in on Friday and we're exactly

what he was hoping would not happen. I think. Yeah, So the strong nonfarm pay will report and the recent economic data actually is a blunt reminder actually that the data are in charge. So it doesn't matter if you're abundant or fulil manager or even FED share Powell. It's

all driven by the data. So for him or anyone to proclaim that, you know, rate rises are pausing or pivoting, it's just really kind of a fool's Errand because you're driven by the data, and the data is what's driving the FED uh and should drive the market absolutely if if you don't mind my adding back in June, the FED communicated that it was going to only hype by fifty basis points. Then two data points came out within

days of the FED meeting. We got um CPI, we got Michigan inflation expectations, and they pivoted to seventy basis point. So Greg is absolutely right. The data is going to drive this and that really renders Powell speech pretty irrelevant. So so Greg, if the data are driving the Federal Reserve, what's driving investors? If you're an investor, what do you make of these data? And where do you go? You know?

What is this circular reference problem that we have? It's it's it's clear to me at least that the markets are focusing less on the data and more on what the FED has to say. The challenge, I think is that the rhetoric coming out of the FED is quite disparate and not all over the place, So the message being what is quite mixed. But to me, it's really

hard for me to swallow that. You know, rates have rallied, risk assets have also rallied um and we have an even senior recession yet and we haven't seen the peak in rates. And we've had one data print David of lower infl UH and lower inflation. So you're a fixed income guy, Greg, what do you do in fixed income given that circumstances? Yeah, so I think it's been this

this this obviously very difficult market for fix income. If you think about where the tenure started this endeavor post COVID, it was fifty basis points right, So you know we're at three and a half now. I do think fields move higher here as we repriced more rate hikes. But I have to tell you, uh, you know we we've repriced is such a dramatic degree that I see a tremendous amount of value fixingcome yields higher all equal is a good thing. Spreads wider all of equal a good thing.

So while we can't time it, I feel really bullish on the outlook for fixed income. Thank you so much, Investco Christina Hooper and p jims Greg Peters coming up. Bank of America veterans Tom Montag and and Finukein joined Wall Street Week for an exclusive explanation of their brand new carbon credit venture backed by TPG. That's next on Wall Street Week on Bloomberg. This is Bloomberg Wall Street Week with David Weston from Bloomberg Radio. This is Wall

Street Week. I'm David Weston. Global. Wall Street got some big news this week. It's two of its most prominent citizens, Tom Montag, the former CEO of Bank of America, and and For Nuken, the former vice chair of Bank America, got together and announced a big new venture fact in parted by TPG and involves carbon credits. Were delighted to say to welcome them now to Wall Street Week for an exclusive discussion about this new venture. So thank you very much, Ana and Tom for being here. And let

me start with you. You're the chair of this new venture. Explain where it came from. How long you've been working on this? Thanks Steven, and good to be here. So, uh, this is an evolution actually of work that Tom and I did at Bank of America, Uh, for our own company. But So for our clients, whereas more and more companies are looking to become carbon neutral, which is the first step becoming at zero, they do an audit, they review what they can do, and there's a delta between everything

they could do and what is carbon neutrality. And the sort of basic practice has been to fill in that delta for the short term with carbon credits. But they are not plentiful. They have had some controversy around them because looking back, UH they've not been well vetted and they may not be as as um as good as they could be. So we saw an opportunity to improve the whole market. Want to fill what clients need to put money into the developing world, in other words, cash

into protecting forests for UH removal as well. So this is carbon reduction, carbon rem NOEL carb and removal. And in order to do that, we needed to set up a system that would be UH much more I think acceptable to not only companies but to the n g O world. So what I'm talking about is that these credits would be vetted through proprietary quality guard rails, they would have third party ratings, it would be a methodology, methodology that's transparent and so people could feel comfortable with

this new product. So, so time you're giving the CEO of this, you've spent a career really in and around the markets, whether Goldman Sacks or a Bank of America. Are you making a market in these carbon credits? Is that the way it's going to you're putting together people who put them together with the people who need them. We're making a market in the sense David, that we're actually you know, we're offering a product that they can buy. Uh,

it's not yet a tradeable product. At some point it maybe, but at this point, you know, we as and said were we just we have we've established rubicon carbon kind of solutions, Penny in the first product we have it. This is what we called rubicon carbon tons, and that is what we are offering to enterprises around the country. We'll tell us what's in that Rubicon carbon ton when

it's available, what is in there. So what we've done is that you know our three words if you go to our website rubicon carbon dot com, our scale, confidence and innovation. And so we basically have already purchased a number of carbon credits and we sell them to you in a basically a portfolio and the port there's two different portfolios. There'll be a third, uh, and they'll probably

be more over time. We have a nature based portfolio and an emissions based portfolio, and we will have a removals and each one of those underlying those rubicon carbon tons in nature has numerous projects that we've already purchased and we curate is constantly. So we we've hired Dr Jen Jenkins as our chief sustainability officer, and not only do we look at them when they come in, but

we're always looking at and curating what's in there. So you would buy the right to retire carbon credits in the portfolio of your choice at any time that you wish so. And do you essentially certify the in fact these credits exist and that they're legitimate? And you and I have talked in the past about things like greenwashing. Does this address that problem to some extent? And do you need the government to certify it? Well, let's just go back here for a minute. I think the problem

with carbon credits is more retrospective than it is current. Retrospectively, it was a nascent industry early on, small players and um standards were not set, so Yeah, in some question places they were questionable, but today we have much more transparency. We're working with NGOs, we are not only will work with those that certify and verify. Today we're essentially taking another step and we are doing our own project level diligence.

So this is sort of an insurance on top of an insurance, and actually beyond that, we're going to be doing some work in terms of insurance itself and risk management. So if you are a client and you came to us, I think that you would have much more confidence. First of all, the projects themselves are forward looking, not retrospective. We recognize what the issues were in the years gone by.

We're not buying renewable projects in O E c D countries, meaning we're not trying to UH make renewables in America, which are actually cheaper and easy to get to part of the credit basket. What we are doing is looking to the developing world to help, and I think everybody needs removables, So we'll be transparent, will be easy to use. The credits are verified, certified, and we're taking a second look at them through uh gent I CANS Group. I think that this is a sort of end to end process.

We are working with developers, were working with bropers and we may actually source credits ourselves in the years to come. And let me come back to you and talk about the future of this business as as it were. How big is the bread box? Well, let's just talk about

how big is the need? Uh? By any dimension, we are looking at a need a delta of three and a half to four trillion dollars a year needed to create and NED zero world by and UH, the scientists, the NGO's governments would like to see us get halfway there by so or at least they're just simply isn't enough money to do that in the current equation. Governments can't do it, philanthropy can't do it, and businesses are really not set up to do it. You will see

more of that in the years to come. But we're talking about four trillion dollars a year that is needed to fill this delta. Meanwhile, through uh, some commitments that have been made, you know, about ninety percent of the world is committed to some form of net zero. But the Glasgow Financial Alliance for Net Zero, otherwise known as Chief FANS, is a collection of five financial firms who have committed to be net zero. For financial firms to be net zero, all of their clients have to be

net zero. That means not just big corporates, but middle market companies, small businesses, and ultimately consumers. So imagine that kind of um task ahead of us to help clients and customers become first carbon neutral, ultimately net zero. Well, speaking for myself, I find it very exciting and we'll be really curious to see how it develops. Thank you so much for sharing with us. That's Tom montag and

and for Nuken of Rubicon Carbon. Coming up, we're gonna explore the large and growing world of private credit with Mike Arrighetti of Aries Management. That's next on Walter Read on Bloomberg. This is Bloomberg Wall Street Week with David Weston from Bloomberg Radio. Okay, credit, it's what makes the business world go round, and years of fiscal and monetary stimulus have made sure there's plenty of credit to go around.

But now the Fed and other central banks would like there to be just a little less lending so we can get inflation down. History cautions strongly against prematurely loosening policy. We will stay the course until the job is done, which is hitting deals, particularly when it comes to private equity. What effects deal making is uncertainty. Uncertainty is the enemy of deal making. But it turns out that as the government regulates lending from the banks more the world of

private credit has exploded. And more you regulate parts of the financial system, the money tends to flow to the unregulated parts of the finance national system. Having all that credit going on outside of the regulated part of the economy is not ideal. But that leaves the question whether private credit will be able to step in as the

banks pull back. Private credit is really important, but private credit has also pulled back a little bit, not because of uh, the availability of financing or because they're stuck with bad loans like some of the large banks are, but because of the enormous uncertainty. And to take us into this large and growing world of private credit, we welcome now one of the leaders in the area. He is Mike Arreghetti, CEO of Areas Management. So Mike, thank you so much. Welcome to Wall Street. Were great to

have you here, Thank you very much. We hear so much about private credit these days and how big it is, how big it's gotten give us your sense of just how big it is right now and why it's gotten this big. So when we talk about private credit, let me just zoom out quickly. We're talking about lending that is happening outside of the banking system, and that could

be in corporate, real estate, infrastructure, consumer. I think a lot of the recent dialogue that that folks are paying attention to is more along the opportunity and corporate lending. That's the most devolved and the most developed market built here in the US and globally. In terms of sizing, no one white knows just because a lot of this is in private hands. But order of magnetitude, the private credit market for corporate than the US is about one brillion.

Juxtaposed that with CNI loans in the banking system, that that due to two and a half times that uh and almost at parity in terms of size. But the leverage loan and HIH yield market. So what effect is the increasing interest rates had the private credit business? Obviously it's affecting a lot of business right now. It's harder to get loans if you can get them at all, They're more expensive. Yeah, I think private credit has tended to outperform when rates are going up for two main reasons.

Number one, the structure of the loans are short duration and floating rate, though they typically reprice every thirty to ninety days, so as rates are going up, the return is going up. Um that. Obviously, in an environment where we're seeing a lot of building the equity markets and valuations are challenged in the high grade markets, private credit is a place where people can actually go to benefit

from from rising rates. The flip side of that, obviously is that as rates are going up, debt service becomes more challenging or leverage borrowers, and so part of the conversation today is as you're generating this bess return, at what point does the incremental interest rate challenge the companies?

I would say, as we sit here today, uh, still really strong fundamental economic performance within the portfolios and not any signs of stress really making their way through as a result of the rate high might just pick up on a couple of things you said there, because I talked to one investor who said there's no such thing as truly bulletproof in business, but these are close to it. And I guess it's because of the two things you mentioned the short duration and also the fact you've got

floating rates, so if interest rates go up, you're protected. Well, I hope that person he spoke to is an area's investor already, but if they're not, I hope to watch this show of bulletproof. Is always something that you don't want to talk about an investment, but I would agree at this point in the cycle, private credit is a good place to be floating rate. As we said, short duration,

but also senior succored. So if you think about where these exposures sit in a company's balance sheet or relative to the value of an asset, today, most private credit loans are sitting in the top half of the capital structure, which means that there's institutional equity supporting those loans dollar for dollar. So there's a significant amount of equity valuation that would have to deterior rate before you begin to

have a conversation about principle US on private credit. Mike, you mentioned areas investors, and I wonder whether you're having, if anything, an easier time in getting investors these days, because interest rates going up necessarily affect the value of equities just because of the discount rate. It makes it less attractive. Has private credit has become more attractive relative

to equities as an alternative investment I think so. You know in areas managers posted three fifty billion dollars of assets globally, and we have funds that we offer across the alternative spectrum, including private equity. I would say, as a general observation investor, appetite for door play equity product is pretty muted right now, simply because, as you point out, valuations are challenged and if you think about the drivers a return in that market, earnings growth is going to

be muted. Availability of leverage is difficult. Cost of capitals by Mike, thank you so much for joining us in Wall Street Week. As Mike Arri got it, he CEO of Arias Management, coming up. We wrap up the week with our special contributy to Larry Summers of Harvard. That's next on Wall Street Week on Bloomberg. This is Wall Street Week. I'm David Weston. We're joined now once again by a very special contributor to Wall Street Week. He

is Larry Summers of Harvard. So, Larry, I have to say, until Friday, I thought the big story was going to be what j Powell had to say. And then those jobs nevers came in, And obviously the number of jobs is really impressive, but also the average hourly wage. Wow, look what we saw was a seven and a half percent annual rate wage increase for the month, a six percent wage increase for the last three months, at a

five percent increase for the year. So it's high, and it's rising, and the labor market is strong, and we're still in unprecedented territory in terms of the gap between vacancies and jobs. And I think that what that's got to tell you is that we had a long way to go to get an inflation down where the FED has said that it wants it uh to be. We don't know where this is, how this is all going to play out, but for my money, the best single measure of core underlying inflation is to look at wages.

It's interesting. That's what Paul Krugman acknowledged today when he said that he was shaken in his views by these numbers. And I think what this is telling us is that the Fed's got a long way to go, and so how is that going to happen? I mean, we heard J Powell talk about the Jolts numbers, for example, say we've got a big gap between the people trying to get people to work and the people actually working. As

long as you have that, you've got this pressure. He said, we've got to get demand down so that in fact we are not seeking as many people in the workforce, But how do they get done. It's not getting done yet. It's not getting done yet. And what that says is we're probably gonna need increases in interest rates. I suspect they're going to need more increased as an interest rates,

and the market is now judging or than they're now saying. Look, every every time they revise their forecast of inflation up, and they regard revised their forecast of ultimate unemployment up as well. And gosh, we've all been at the airport and they say it's leaving at seven thirty, and then they say it's leaving at eight thirty, and then they say it's leaving at nine thirty. And when I see that happen, I think it's leaving at eleven. And it's

something like that with these economic uh forecasts. So I hope I'm wrong, but my sense is that inflation is going to be a little more sustained than what people are looking for. And my sense, uh also is that it's much harder than many people think to achieve a soft landing because there are all these mechanisms that kick in. At a certain point, consumers run out of their savings and then you have a wily coyote kind of moment

where consumption falls off. At a certain point, people start putting their houses on the market, and then you see how house prices falling, and then other people rush to put them on the market. At a certain point, you see credit drying up. And when credit dries up, people can't pay back. Uh, they're old, they're old borrowing. So there is this proposition We've talked about it before on

the show, David. It's called Psalm's rule that says that when the unemployment rate goes up by half a percent, it goes up by more than two percent. And that's because once you get into a negative situation, there's an avalanche aspect, and I think we have a real risk that that's going to happen at some point. So to continue your airport analogy, when is the plane going to leave?

Because we heard j Powell this week say don't pay as much attention to how fast we're going, because every jumped in the fact he was pretty clearly seeking fifty basis. He said, pay attention to the terminal rate. I'm not sure the markets did that. So where do you think the term rate is now? Look, I've been saying that relative to the five, it's priced into the market a

little below five. I think that's got to be low, or likely to be low, because I always try to look for possible errors, and four seems almost impossible, and six is certainly a scenario we can write. And that tells me that five is not a good best uh guess for where it's going to be. In terms of what will happen, I guess. I think there's an old saying that things happen faster than you think they will, don't happen as fast as you think they will, and

then they happen faster than you thought they could. And I think that may be the way it is with the downturn. I don't know when it's going to come, but when it kicks in, I suspect it will be fairly forceful. I got an email, as you know, Larry, this week from a loyal viewer of Walter, particularly a loyal viewer of yours, saying, I really love hearing from Larious Summers, and he asked the question, he said, what's

so magic about the two percent? I mean, why can't we live with three percent or four percent for that matter. First of all, I think it's important to understand that, having failed for a while to hit two percent, it's kind of problematic then to declare that it's no longer our goal, even if it was a somewhat arbitrary goal

in the first place. Second, we've already backed away from the two percent in a sense, we've been for years well above two percent, and nobody's saying we should swing below two percent, so it all averages out to be two. So in some sense, we're already not really trying for a two percent average inflation target. We're trying for a two percent minimum inflation UH target, and that's different than what we originally set out to So we've already eased. Third.

If we settle in for a three percent inflation target, then where do we think it's gonna go. Presumably there's gonna be a low point of inflation in this cycle, David, and from that low point it will rise. So saying three percent as a target for what we're disinflating too, isn't saying three percent as an average for UH the

next cycle. So what I think we should do is stay with the two target, recognize in as I think is surely right UH that uh, that's gonna be a low point, not at average, But I think that's all right. There was news that went beyond these economy this weekend. It had to do with China. We had demonstrations at the beginning of the week. They seem to be settling down a little bit because there's easing off on the COVID restrictions, but it's pretty clear that the Chinese economy

is struggling some in part because of those restrictions. Give us a sense of what the risks are there for the global economy because of what's going on to China right now. Look, it's possible that we're going to gain a little strength because it's white possible that they are going to open up a bit in response to these UH protests, and then the Chinese economy is going to go faster, and when it goes faster, that will be an impetus to commodity prices that will help parts of

the global economy. I think the challenge for them is that they've only got one fifth as many intensive care units per person and a third as many nurses as we do per person, and they don't have much immunity, and so it could spread like wildfire, and they could have a very scary situation, and that's their tension. Really, they can save the economy or they can save their populations uh near perfect health. But I don't think they're

gonna be able to do both well. And to your point, Larreas seems to be that we can sit here and say you should ease up some of your cover destrictions. They have to be data dependent in their own way. It depends on how many infections they get, how many intensive care units have used. They may have to adjust their approach. They're surely going to have to adjust. They're surely going to have to tight trate uh their approach over time, and I don't think it's gonna be easy.

I do think sooner or later they're going to have to do this, and they're not gaining a lot by postponing it. So I think a managed exit from zero COVID is probably the right thing for them to do, and I think the protesters have probably pushed them in that direction, and that's probably a good thing for them and for the global economy. But it's going to be a very rough patch. It's so great to have you here and have you here in New York as the wonder world to be with you. Thank you so much.

That is our very special contributor, Larry Summers of Harvard. Finally, one more thought, the power of no. All of us like to hear people agree with us, so we're none too happy when people go the other way, when they tell us that we are just playing wrong, like former Vice President Mike Pence recently did to Senator Elizabeth Warren on the subject of abortion counseling Senator Warren, you couldn't be more wrong. But sometimes being told no is exactly

what we need, whether we want it or not. Take for example, as an amputent and his ill fated decision to invade Ukraine, something that hasn't gone particularly well for him. A bunch of countries are watching him make mistake after mistake and not wanting to associate themselves with, as Donald Trump would say, a loser, and people at least those outside of Russia suspect Prutent's problems are the result of his being surrounded by yes men. I don't think there's

any question that Russian intelligence got this wrong. Or consider the plight of President Z of China as he enters his historic third term as president. A month ago, he emerged triumphant at the end of his twentieth Party Congress with his hand picked team. As described by Very Lovely of the Peterson Institute, we now have what we might think of as all the King's men. But this week President g was confronted with demonstrations protesting his zero COVID policy.

This is a big deal, these political protests, because they're happening across the country at the same time in multiple occasions. You just have to wonder whether that hand and picked team is exactly what President ge needs right now. And when it comes to the power of no maybe that is exactly what former President Donald Trump could use down at marral Lago about now, as he managed to hold a dinner party that included yea who has been accused of being anti Semitic, and let him bring along with

him a friend who everyone agrees is anti Semitic. Nick flentis avowed Nazi sympathizers, white nationalist, anti semi I mean, let we go through the list, and it long lasts. It looks like Mr Trump maybe getting a taste of no from leaders in his own party. From Senate Minority Leader Mitch McConnell, there is no room in the Republican

Party for anti semitism or white supremacy. To the likely next Speaker of the House, Kevin McCarthy, I don't think anybody should be spending any time with Nick Flinch as he has no place in this Republican Party. To Mr Trump's former Vice president himself, Mike Pence, I think the President demonstrated profoundly poor judgment uh in in giving those individuals a seat at the table. It may not be what we want to hear, but sometimes no is the

best answer. That is, if we are listening, that does it. For this episode of Wall Street Week, I'm David Weston. This is Bloomberg. See you next week.