How to Trade a Credit Expansion

(upbeat music) - This is the Markets. I'm Chris Hussey and today is Thursday, November 13th and we're here on the Goldman Sachs trading floor with Anshul Sagar, who is global co-head of our fixed income currency and commodities business within global banking and markets. Thanks so much for joining us again. - Thank you for having me. - All right, let's cut right to the Fed because we're between meetings, but that's always a big thing in rates markets. All to the government's reopening. We're finally gonna get some data. Is a Fed cut a sure thing or is there still some uncertainty about that in the December meeting? - So the committee's a little bit fragmented for lack of a better term. People have strong views on all sides of the spectrum. There are those that believe that the Fed should basically embark on a full cutting cycle. Those that believe that the Fed should just stay on hold. And then there's the entire spectrum in between and I think Powell falls somewhere in the middle where he wants to basically have a December cut, but then take a step back and reevaluate. They would have cut 75 basis points. The funds rate would be in mid to slightly high threes. That's a good place for the Fed to basically step back and take stock. The big question mark, two big question marks. One, we have had no data as we were just discussing before we started. And two, the other big question mark is we don't know exactly what the impact of AI is going to be down the road, but even on a spot basis. It does seem like, based on what corporates are putting out in their earnings statements, that corporates are basically pulling back from the labor market. See, we had this big ramp up in employment on this side of the pandemic. And corporates haven't really cut the excess capacity that they built over this time. And maybe they choose to do it now to rotate some of those resources towards trying AI as an experiment. Certainly some of the big corporates out there have put press releases stating that. Is that a big part of the employment report? Probably not. Is that a big part of labor income? Probably yes. Odds are, we're in a case-shaped economy where some quantum of the economy is actually going-- is roaring, is going to continue to roar. But the labor market does feel a little soggy. So it's a long-winded way of basically saying that I think they should cut one more time and take pause. The committee is going to do what they want to do. But having data before they meet in December is going to be very important. And that really is a big unknown as of now. You mentioned the case-shape economy. And that is the concept that there's one part of the economy that's up and to the right. There's another part of the economy that's struggling. Is that what's going on in long-dated funds? When you look about a 10-year yield with all this rate cuts, with all this cacophony, we're 4.1% about the same we were a year ago. You're not much going on. Is that what's going on there? It certainly seems that way. Overall growth, again, this year seems very robust. You're going to get the one big, beautiful bill impact next year. So we expect it to be a quite meaningful tailwind. 2 and 1/2% of GDP fiscal expansion through the first half of next year. Very meaningful excess fiscal expansion. So that's the top leg of the K. By the same time, labor is not doing well. Inflation continues to be a problem. Consumption supported because the top 20% of wage earners continue to spend, continue to travel. But the Fed's mandate is the labor market. Their mandate has not growth and inflation. It is labor and inflation. Therefore, I believe they must cut if labor is doing poorly. So we'll see how this plays out. But those are the things that the market's debating. A lot of give and take there. You mentioned the fiscal expansion. That's a supply issue, arguably, for the bond markets. Are you worried at all about a supply issue hitting the bond markets next year? I am not. Right now, I think there's so much else that's going on. This is a bit of a handover. I think we're going to go through this process over the next six to nine months, perhaps longer. Where this side of the pandemic, for the first five years, it was everything was fiscally driven. You just wanted to be long. Any real asset out there did not need to discriminate. If it's not a government IOU, you want to own it. The handover that's occurring right now, and that I think will go on for many years to come, is from fiscal to credit expansion. Now, credit expansions are very different. They have a very different flavor than fiscal expansions do. You have to pick your spots. Again, credit expansions can be a lot more powerful than fiscal expansions. To the extent one believes that private market participants are better allocators of capital than central government is, credit expansions can be enormously powerful. But there are winners and losers when it comes to credit. So that's what's going on in the background as we see it. When the early innings of that, the AI data center wave, all of it, basically points to trillions of dollars of credit expansion in the offering over the next five years. So that is the big theme. I think that's going to be a theme for the next few years. Again, big question mark on monetization of AI. But if one sets that aside for a moment, I think that's the dominant theme here. - Yeah, and credit expansions, of course, carry their own risks. Are you worried at all? I mean, we've seen some private debt market failures here already early on. Are you worried at all that we don't have a handle on that market, or do you feel like no, that's just much to do about nothing? - From a macroeconomic perspective, it is fairly buttoned down because these are closed-ended funds with long-term capital. Leverage in these funds, private credit and BDCs, is materially limited compared to what we witnessed last time around. The fiscal stock, to the extent that plays into it, is much higher today than it was in the early 2000s. Remember, the federal government was running a surplus coming into the 2000s. It's something that we don't even think about anymore. - Hard to imagine. - Exactly. So again, very different base state of the world. So from a macro perspective, not at all. From a sentiment perspective, very worried about it. Sentiment matters a lot more when it comes to credit expansions than fiscal. You have a few banks going down. You have CRE issues. You feel very confident that the world will bounce back from it. There is private economy is getting free money. Credit expansion's not so much. Someone loses when you have any of these failures. So yes, so to the extent one is trading markets in the seat, one has to worry about it. From a start-to-finish perspective, it's probably not that meaningful yet. I think when debt servicing costs become a very large part of household net income, that's when you start worrying about the credit expansion. That's when it's long in the tooth. That's when basically the Fed has to cut all the way to zero and the system's still very levered. I feel we're very far away from that. - Yeah, I agree with that. But one other risk though that's out there simultaneously is the stock market to a degree. There's been a lot of talk about an AI bubble. Does that concern you at all? - It doesn't concern me as much as it concerns the market. I'm still bullish stocks overall. The change is that you could unabashedly belong any real asset as we discussed. When it was fiscally driven, at this point in time, you have to pick your spots. It does seem to me that diversification doesn't make a whole lot of sense anymore. You pick your spots, you limit your capital, you keep dry powder to scale up. If there is a pullback, you just trade it very differently. So if you get the spots right, it can be very profitable. You get the spots wrong. You have to acknowledge that it's not gonna be profitable. So if you believe in the AI wave, semis are a great sector to own. EM generally benefits in credit expansion. So there should be some quantum of EM in any portfolio. AI wave, again, is very bullish commodities, especially metals. So that should be a structural trend. So a portfolio that's focused on just that as opposed to very broadly owning rustle or anything seems to be the better trade here. But again, if in a fiscal expansion you wanted to be 10 on 10, it didn't matter what the level was. Today, you want to be a seven on 10 so that if there is a pullback, you can scale up. You have to trade around it. - Nah, it makes sense. So we want to trade around, but put a bow on it though. What exactly is your favorite trade here? - For me, it's being long semis, being long EM, being long commodities. I don't think it's a rates trade. - Fascinating, all right. As we go out into the rest of the year, what are you watching for most carefully? - The data, we haven't had any US data in a while. So again, it's a question mark in terms of how the consumer is doing. So far and away, for me, it's the payroll report and dissecting the payroll report. - Yeah, and that payroll report, it's going to come up in drips and drabs actually over the next couple, three weeks. - Yes, so we'll see how it plays out. Again, the calendar matters. There's a Fed meeting on the 10th. The payroll report right now is you're marked for December 5th. That means the Fed's going to be in blackout as a rates trader. Are they going to cut? Are they not going to cut? We will just find out in the meeting. It's the first Fed meeting in the longest in September of last year, where we'll likely be going into the meeting, not knowing the outcome at all. The market's probably going to be somewhere in the 40 to 70% chance of a cut, and then they will do what they will do. - Yeah, I know it's fascinating. Between now and December 10th, we may get three payrolls. - We may get three, or two and a half. - Two and a half. - Two and a half, because we might not get the U-rate for October, but we'll see where it comes out. - Anshul, thanks so much for joining us. I really appreciate it. - Thank you for having me, Chris. - That does it for this week's episode of the markets. I'm Chris Hussey. Thanks for listening. 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