The $600 Billion Loop | Jeff Klingelhofer on AI, the Return of Bonds and the Fed's Third Mandate

It's AI-captex that's driving the stock market, and it's a stock market that's driving that ability of that high-end consumer, continue to consume, which is all very circular in nature, right? If any one of those links in that chain breaks, it's a very tenuous setup. Part of the reason why we haven't had a classic business cycle is because of all of that Federal Reserve intervention, and its direct focus on financial markets. And so I think what it's done is it's lengthen that business cycle as good business analysts to be trying to focus on fundamentals, what's ultimately driving individual companies, how those companies are driving the stock market, but what really drives prices is sentiment. And what sentiment rolls over, it's tough, right? - Jeff, welcome to Access Returns. - All right, it's great to see you, and great to be here, so I appreciate it. - You are managing director at Aristotle Pacific, and the portfolio manager across several of the firms fixed income strategies through this role that you currently sit in, and prior roles at PIMCO in Thurneburg, you had a front row seat to global fixed income markets through many different regimes, many different credit environments. And today, what we'd like to discuss with you is the current macro environment, Fed policy, credit markets inflation, and where investors should be looking for opportunities in today's market. People always say that the fixed income guys are the smartest guys in the room, and much smarter than the equity guys. So Jack and I are hoping today that some of this intelligence rubs off on both of us. - We would have to do a lot of work to rub off on us, Justin, we've got a lot of work to do. - You brought it. - Well, hopefully Jeff is patient with us as we work through this. You said that the markets are focused on an increasingly set of narrow things that are working, and really are an appropriately waiting some of the headwinds out there, so can you explain where you're coming from with that? - Yeah, look, the way I would describe it is, we've all talked about this K-shaped economy for quite some time. And what we are seeing is, the economy is hummied along, but it is relatively narrow in the sense that there's only a few things that are really working, and even those couple of things that are working are very interrelated. And so what I really mean by that is, if we just unpack where GDP is today, if we unpack the reality of higher rates, higher inflation, having pressure on that lower end consumer, that's old news, that started in 2022 with the rising rates. Now it's continued to spread, and it's been made notably worse by the brand increasing oil prices, et cetera. And at least for the moment, we've got a temporary reprieve that's helping to alleviate that. But really what's been driving the economy is this incredible AI cat-x expansion, right? We've got $600 somewhat billion from only a handful of companies. And for the moment, there's lots of questions around ultimately where AI goes, it's impact on the consumer, it's impact on the broader global economy, but in the build-out phase, it's for real. We need real people, we need real things, we need to be digging in the ground, we need energy, we need copper, we need chips, we need all of these things. And so that is a massive, massive tailwind to the US economy. It's also been a massive tailwind to equity market returns. And so the more narrow focus that we've been seeing from the consumer is that really the only part of the consumer that's holding up amongst this massive tailwind is that increasingly high end consumer. And they're only holding up because they are the ones that are benefited primarily from asset price appreciation, right? House values have gone up, equity markets have done well. And so that higher end consumer that has a lot of assets continues to spend. They're ones that are really propelling the economy. That middle and lower end can consume or acting as directs. We're seeing delinquencies increase. And so when I think about what's working in the economy, it's AI-CAPX that ultimately would potentially prove catastrophic, but I think if nothing else would act dramatically to slow where the economy's currently heading. And how does that sort of view play into or weigh into how you're looking at sort of the fixed income markets today? Yeah, the way that I would think about it, fixed income markets are very different today than what many folks think about the fixed income markets. If we just kind of take out that last 15, 18 years of unfortunate fixed income markets and what we know, that's the vast majority of many of our investing experiences, right? That was a period of very low interest rates. And it was a period of what I will directly call market manipulation by central banks. Now, for many good reasons, and I'm sure we'll get into that here later on, or if you want to. But the reality today is that we have emerged from a period of what was below trend inflation. And we have emerged from a period where central banks were trying to push towards price stability by actually trying to create inflation, right? We were significantly below that 2% inflation level that most central banks around the world are trying to find as price stability, and we are struggling to get there. And one of the things they did in that environment was keep rates very, very low to help prop up the economy to pull the man functions forward and act as a catalyst to propelling the level of prices up towards price stability. That's not the environment that we're in today, right? The environment that we're in today is we have above trend inflation, central banks are trying to pull it back down. And so the reason why I want to start with that is backdrop. It's because we have to think about what fixed income is that serves within investors portfolio very differently. So first, I would say the level of income generation is no higher than it has been in the past, right? It's relatively easy for fixed income investors to get five and a half to mid six percent and very high quality fixed income assets today. But then secondly, and most importantly, fixed income is always meant to be balanced in investors portfolio. We're not supposed to be the most interesting folks in the room. I wouldn't necessarily even say we're the smartest by any stretch, but we're definitely not supposed to be the most bald on the most interesting. And so traditionally, what happens is if the economy was to slow, central banks around the world, the US Federal Reserve would be cutting rates that pushed the level of prices of fixed income up. And it acts as balanced within the context of a portfolio. And really, that's tremendously important. And I think that's how folks should be thinking about it. One is income generation as a yield source as part of their total return equation. But even more importantly, within the context of overall equity and other risk asset allocations, what kind of protection and balance can fixed income really provided today's environment? I think that's a very interesting point that a lot of times in investing, you see in an environment, take place, and then you assume that that's sort of the environment that you're going to be in going forward. And that can be such a challenge for investors. Whether it's a fixed income regime or an equity regime and how that can be very different than what the historical precedent actually is and has been or will be. So I think that's a very fair and good point that you bring on. Yeah, look, I think still one thing that all of us have grown up on just simply isn't the reality, in my opinion, of the world today and as we look forward. And it's one more thing, right? Central banks were created for the very purpose of acting in an independent way to keep us as a global economy, as a US economy, from experiencing runaway inflation, right? They were created with the sole purpose, essentially, to act as a break on, quote, the reckless fiscal spending. And in general, a way you should think about that is central banks were created to pull inflation down or prevent it from rising rapidly. And it was an entirely new playbook for all of us when hand was the first country to really slip into this inflationary period. And there were a lot of fiat entities, and for key included that said, all you have to do is just throw more money at the system. Anyone can overcome below trend inflation. You're just not doing enough. Then he became chairman of the Federal Reserve. And he wasn't successful at breaking us out of this low inflationary environment. And so really to me, central banks are most effective doing what they were designed to do, preventing this runaway inflation and that's the environment we have today. And we were all along for the ride with all of these various monetary experiments in trying to arrest deflation and disinflationary environments. It's interesting thinking about them as sort of their goal is to prevent runaway inflation because for that huge period, they didn't even have to care about runaway inflation. They could basically do whatever they wanted and it didn't impact inflation. So it's almost like they maybe forgot a little bit about the playbook because it was so long they didn't have to use it. - Well, I think that's exactly right, but to be fair, it's not just them. It's all of us, right? It's all of us. And I think one of the big things and one of the big questions in markets today, especially as we emerge out of this period where chairman Powell is now in the history books and we have chairman coming in is how does worse think about this? How does worse think about the balance sheet? How does worse think about the quantitative easing? How does worse think about both Greens and both? What, will there be a worse put? And I think all of us have come to this belief that central banks have our back as investors. That's what they're there to do is provide financial stability. But that's just not the case in my opinion, right? I think what central banks are designed to do, the US Fed already is a very unique central bank in this world in the sense that it doesn't only have one of the date, it has two or I will actually argue or I assert very directly, it has three. But if we just focus on those two and just even really that price stability mandate, financial returns, financial assets affect all of our ability to consume and our ability to consume affects price ability, inflation, or lack thereof. And so that's what central banks care about. That's what the Fed cares about. They don't care about financial markets. They only care about financial markets. into that financial, into that price stability equation. - We're gonna talk a lot more about central banks in a minute, but first I wanted to get back to AI CapEx because I was interested to talk to you because we've talked a lot of equity investors about AI CapEx and they kind of look at it, they're looking at it from a growth perspective, but I would think a fixed income person is thinking this more from the perspective, like I got to get my money back. Like in a different way, the fixed income people would probably look at this. So I'm just wanna give you have any insights on what you're seeing in terms of this massive AI CapEx from like the fixed income side. - Well, the first thing that I'll say is, we started off by talking about there are very few things in the US economy that are really truly working. When you think about where roughly a $30 trillion US economy and you think about $600 some billion of CapEx coming all online, all this year and from all they four or so companies, that gives you a sense of just, when we talk about 3% GDP to growth, that's essentially it. So it's very concentrated, but it's very important. And $600 billion is a whole heck of a lot of money, right? We feel like this. And so, the first thing that I would say is, when you have that much CapEx, you will take money in any way, shape or form that you can possibly get it. And so we're seeing it come from the equity market, and equity raise, right? We just came off the SpaceX IPO, but right thereafter, we can a half later, SpaceX tapped the fixed income markets. And we've seen the same thing from Microsoft, from Neta, from Amazon, from all of these companies as they engage in a CapEx build out. And you're right. The old joke is that fixing income investors, we're always grumpy. We always wake up on the wrong side of the bed, and maybe that's true or maybe it's not. But what I would really say is it's because, we care about getting our money back. If AI works incredibly well in profits or even beyond our wildest imaginations, I don't benefit as a fixed income investor. I get my money back, that's the upside, I get interest along the way, and the downside is the exact same. I can potentially lose it. So we have to think about it very carefully. Thankfully, almost all of these major companies are incredibly high quality tech companies with very, very strong balance sheets. Really both of them started with close to no debt on their balance sheets. And they're just beginning the phase of tapping the bond markets, tapping the debt markets to really raise capital for it for these AI expansions. All of them have very strong business lines away from AI. And so the way I would think about it is, it's very attractively priced today, in the sense that you've get a six to 7% type yield, depending on where you play up the yield curve and what the quality spectrum is. But from companies that are notably higher quality and where else you might have to look to get that similar yield profile, the big headwind is, we know that markets are tapping the market today, and we know that they're gonna tap the market tomorrow. And so there's just this endless supply that continues to come, and that's keeping yields maybe artificially wide, relative to my opinion of the risks of being repaid, versus almost the entirety of the rest of the fixed income markets, the exact opposite of the equation, right? Investors are pricing in almost no risk of recession, of defaults, of any challenges in the macro economy. And I would say that the challenge potentially in AI is much more, but the cost quite interesting from a fixed income perspective. - So do you see any of the dangerous stuff that you have some people out there in the news talking about, the starting to get into dangerous forms of financing and things like that, like around the edges, are we seeing any of that yet? Or is this still pretty solid? 'Cause to your point, it was from cash flow for a long period of time, which is different than something like fiber back in the day, this seemed like it was safer coming out of the gate. Look, I think that's the million dollar question. My honest take is at this point, we're not seeing quote, "Dangerous forms of financing." What we are seeing is the reality that what we have ascribed as a market as just kind of a one-way train up into the right, increasing forever overall revenues coming from AI, increasing adoption, is a challenge, right? We haven't ever experienced any prior technology that has gone in a perfectly straight line. I will date myself here a little bit, in terms of the internet age, right? I started on bullet-board systems, and then I went to something that called CompuCert, and then I went to AOL, and then it moved to MySpace, and a million iterations right along the way. And MySpace is still, or sorry, Facebook is still around, but all the rest of them have moved on, been acquired, failed, whatever in many of its various forms. And so I just think that we have to create, keep that in mind as investors. I don't think we're seeing dangerous forms of financing, but we will see increased competition. There will be winners and losers, and there will be competition for our dollars, both from an innovation perspective, but also increasingly from a price perspective. And that's really the thing that has me scared the most, is there's a lot of companies that aren't the best, but there's a lot of companies in AR that are pretty gosh darn good, and charging a whole heck of a lot less. And so I think we just have to think about what that revenue equation is, and the multiples that we're assigning to it in, and the same thing on fixed income. We have to make sure that we are focused on those companies that start with just absolutely bulletproof balance sheets, have a very large vote around their AI offerings, and really have the ability to pay us back at the end of the day. - Jeff was that you on the raging bull message board? - I don't remember if the raging bull. - Constraint, constraint is really my view. There's opportunities, but there's always risk, and we just have to remember that, just because it's sunny today, doesn't mean that it won't be stormy tomorrow. - Well, it was funny, we had Cliff Azness on, he admitted he was anonymous on the Yahoo message boards back in the day, making some comments on different things. So it's a very different world now than it was then. I want to ask you, going back to the idea of inflation being here, one of the questions that we talk about a lot in the podcast is for many, many years, bonds acted as a great hedge for stocks. And now we have some debate around that, which we haven't had in a very, very long time, I'm just wondering, as like a fixed income person, can you kind of put that in context, like how you're thinking about the correlation between bonds and stocks and maybe bonds as a hedge for stocks like in a more inflationary period? - Well, I think you nailed it right there on the head in that inflationary type period. And so generally speaking, when the economy is doing well, we have inflation and stocks are working incredibly well because the economy is doing well. And bonds generally are lackluster because rates are right seen to potentially bring down how well that economy is doing. And that actually may be that environment that we have today. But really the most important point is that is absolutely the environment that we had coming out of the global financial crisis, coming out of US Federal Reserve rates that were pinned at zero, coming out of that period of well below 2% inflation and coming out of that COVID period where the Fed had to ultimately raise rates to arrest what was a runaway inflation because of the supply shock from supply constraints around the closing due to a global pandemic. And so that was a tough journey, but it was also a very predictable journey, right? We all knew that after a decade of financial repression after a decade of sewer rates, there was only one direction that rates could go and that was up and that's painful for fixed income. But we've taken that pain, we've taken that medicine. And so maybe we get a hike or two out of the US Fed, maybe we get a cut or two, but really I think it's pretty hard to argue that we're in a pretty comfortable spot. Rates are much closer to quote neutral, they're not necessarily stimme-delive, they're not necessarily holding back the economy today. And but that puts us in a very different backdrop because when equity markets might not work in a recessionary type period, almost assurably we will all be consuming less, almost assurably inflation will be coming down and the Fed will be doing what the Fed is supposed to do which is cutting rates. And so that's really that all of the pain, all of that lack of negative correlation, what most investors have experienced over the last decade, we have to remind ourselves that's not normal because it's not normal that we started with zero rates, it's not normal that we started with one percent inflation. This is actually the normal time period. And so what I expect going forward is, again, as equity markets are potentially experiencing stress, given that narrowness of the economy and just given traditionally within the economy, central government will be cutting rates and fixing how will serve as a tremendously valuable hedge to equity assets, but not only equity assets, but also credit assets, right? We have to think about how we use treasuries versus maybe other credit actors within our fixing, how portfolio is providing balance because it's the outcome that our clients are after. Yeah, that's such an important point because starting point matters, right? I mean, now we're starting point is higher rates and our starting point is higher inflation before it was basically zero and zero. That's a very different dynamic going forward as you think about bonds as a hedge for stocks, right? That's exactly it. That starting place matters and today is very different. It's very different than what most of us know within the role of fixing come because this hasn't just been one or two or three years. It's been a decade and a half and that's just the reality. We haven't seen a recession essentially since the global financial crisis in 2008, but business cycles are healthy and we will get a business cycle. I feel very confident in saying that, you know, ask me on timing and of course the old adage that predicting the future is easy and unless you ask me, sorry, predicting what might happen is easy unless you ask me about the future or however that old quote goes. But today is a very different starting place than where we have been. Do you think we're just, you brought up the business cycle? Do you think we're in a different scenario with respect to the business cycle because you can argue if you look through history, we're having like less recessions than we used to, So people argue we have maybe more rolling recessions now where they happen in certain areas, but they don't happen overall. Like do you think something's changed significantly with the business cycle versus what we saw in history? I don't. Like people ask me all the time, what ends this incredible expansion that we've had? And my honest answer is I don't know and nobody else does either. Right. So if anyone tells you they they have to crystal ball that got the playbook. I would question exactly what what they know that potentially all the rest of us still. But what I will say is my general answer is I think what we get this time is just a regular regular boring old business cycle where the fed is raised rates. We've seen inflation move up that acts as a demand dampener on all of us. It's exactly what we're seeing. We've already talked about that. And eventually that over exuberance just rolls over just a very classic business cycle. I think what we've all been conditioned as we looked for the canary in the coal mine because what we've had is right a global financial crisis where the financial system was just in broad meltdown. Well, how it was a global pandemic. I think what the biggest thing that I would point to is part of the reason why we haven't had a classic business cycle is because of all of that federal reserve intervention. And it's direct focus on financial markets. And so I think what it's done is it's lengthened that business cycle. It's allowed us to keep into potentially those periods of over a bazooka runs from longer than maybe is even healthy. But it hasn't killed the business cycle. And so again, we're seeing the pressures build any one's best gas in terms of the time of eventually when it happens. One of the things I like to say is all of us focus on fundamentals, right. As good business analysts, we try and focus on fundamentals. What's ultimately driving individual companies, how those companies are driving the stock market, but what really drives prices is sentiment. And what sentiment rolls over its tough, right. We're all just been conditioned to to bid a dip to belief that, Marl be better, perhaps than a weekday today. But after a few weeks or even potentially a few months of things just going down into the right versus up into the right, our reaction functions become very different. And that's the business cycle. So we have to focus on sentiment is still very, very strong within credit markets, within equity markets. And no, I don't think the business cycles dead. I think it's as alive as it for has been. And we need to focus on on the business cycle. I think it was great about that answer is you're talking more about a garden variety like business cycle recession type thing. You know, so many people are looking at what happened for a long period of time and thinking like it has to end catastrophically or it has to be 2008 or something like that. Because we saw that it doesn't seem like it seems like this is a more reasonable way to look at it than it has to end with with crisis and catastrophe. Well, we can all hope that that's actually the way it's that it does come to fruition. It doesn't. But I think at other important point is we also have to remind ourselves that global financial crisis in 2008, which was really that last business cycle was just tough on everybody. But if we go to one prior to that, right, the internet boom and the tech bubble, ultimately, it was a little bit different. It was much more dramatic within markets than it was on the main street economy. And so if anything to me, that next business cycle again, full humbleness and recognizing nobody knows what happens tomorrow. It feels a little bit more like that where the markets may have a little bit more of a wild ride than just broadly the underlying economy. And it's again, back to your point is it's because starting place matters. And so I think it'll be really interesting to watch and fascinating for all of us within the markets. I want to shift to the Fed and I was watching some of your appearances and you've talked about this idea of a third mandate for the Fed in addition to employment and stable prices. Can you talk about what that is and what that means? It's something I'm pretty passionate about. Look, I will, I'm going to go a level further. It's to me, it's not even debatable. The Fed does have a third mandate. And so I will point to a lot of people don't believe me when I talk about this. And I will say just pull up the actual document that governs what the Federal Reserve is supposed to do. And so it's the Federal Reserve back to 1913. And it basically is the mandate from Congress. And it says says that essentially the central bank with the US is to pursue effectively the goals of maximum employment, price stability, and moderate long term interest rates. Right. And so I may not be very smart, but I'm pretty sure I can count to three and I just counted three. And so that third mandate technically as it's given by Congress is moderate long term interest rates. The question becomes what the heck are moderate long term interest rates and how does the Fed think about them. And so I've actually asked a couple former Fed officials, but importantly, that Chairman Powell actually got this question in a press conference, maybe four or so press conferences ago, and almost never comes up. And you should have seen the smile of my face as it came up because it's something I've talked about for quite some time. But his answer essentially was as good as any. He said a couple of things. What he said ultimately is like we the Federal Reserve don't know what moderate long term interest rates are. And they changed throughout time. And moderate long term interest rates are what you get when you successfully balance maximum employment and price stability. And so that's very similar to a couple other Fed folks that I've talked to. And on the surface that may sound not interesting and almost like you could dismiss it out. Right. But I actually would argue the exact opposite. I think it's tremendously important. And I think it's tremendously important because we've already talked about a few of these things. The US Fed is one of the most unique central banks in the world. It has again, let's just say two mandates almost every other central bank has one mandate and only one mandate that's price stability two percent inflation. You get that and nothing else matters. The US Fed at minimum has those two mandates price stability and maximum employment, which are oftentimes two different sides of that teeter taught her right. And I think we can look at today's environment is exactly that. It's no it's not even controversial that we have inflation that's above the Fed's target. And it's maybe a little controversial of how strong labor market is wasn't that long ago. We were talking about some potential weakness on the labor side. And so on one side of that coin, you could say the Fed should be raising rates on the other. You could say the Fed should be lower rates and what should the Fed be doing. And what I will say is that third mandate recognizes inherently that the economy changes throughout time. It's much like a lot of what makes that American system great is the flexibility that the founding folks this instance right the people that put the central bank there gave them a lot of flexibility to look at today. Look at the drivers today and adapt. And so I will argue that there's kind of been three primary iterations of that third mandate. The first one was financial stability and we've talked about this. It's not because the Fed cared about the level prices of level of stocks. It was because in a time period where they were trying to push inflation up. If they engaged in QE one, we do they pulled forward our demand function. They propped up the level of assets within the economy. They made all of us more confident to go out and spend and that helped keep the level of prices up towards price stability. Now that evolved. And so in my in that 2020 time period. This was before the runaway inflation. I actually think chairman Powell told us that second iteration became social stability. So we went from financial stability to social stability. And what the Fed told us was is they used to be very reactive right. Sorry. They used to be very proactive. Sorry. Let me very careful. These be very proactive. Once overall employment got too strong. They worried that it would bleed into higher asset prices higher consumption. So they would proactively raise the level of of rates to ensure that that didn't happen. But because we came out of that period of below trend inflation, the Fed said we have been wrong in how we've run monetary policy and what we learned is by keeping that expansionary. Out of climate rate very, very low for a long period of time, it actually compressed the wage gap and we like that we want more of that. And so I think coming out of 2020, the Fed actually focused on social stability. And we saw that right we saw low wage income workers really close that wage gap versus high income workers. But as we look forward, I think again. The Fed has redefined that third mandate and it's now one of inflation expectations stability. And the reason why I think all of that's important is because that puts us squarely to where we are today and exactly what we heard from worse coming in, which is the Fed is unambiguously committed to 2% inflation. We've been too far away from it for way too long. And we're going to get back. And so I think that we have to as investors remind ourselves that the economy is different today, the way the Fed thinks about the economy is today. And I really think that third mandate. And if I'm right, inflation expectations stability. That's where we should be watching to make sure that. After five years of missing on the high side, if we keep on going, that's going to be a challenge and the Fed isn't willing to tolerate that anymore. So I think that's actually the driver of what they're looking at today, even more so than those first two mandates. I could be way off on this because I am definitely not a fixed income guy, but I'm wondering if like the aggressive use of forward guidance also plays into that because if I want stability, I probably want to be telling people what I'm doing way to dance and like not surprising anybody. I mean, does that make sense? It absolutely makes sense. And I think it to me, the answer to that question is it depends on what regime you were in. And so look, there haven't been many Federal Reserve chair folks that have started in one period and exited in another right. And how was one of those he took her a fed with well below trend inflation and the exit to defend with well above trend inflation. And I think one of the things he could have done a little better was make that transition and recognizing that and shift the fed policies because it's no different than running a business right you run the business in a very different way when things are going incredibly well, then when you have to hunker down cut costs. Think about preservation more so than expansion. And so. In today's environment, all of that forward guidance, I think is much less useful than it was in the past. Because the primary tool that the Fed has, interest rates were already very low. You had to rely on all sorts of other things in order to hopefully propel the economy. But I think really the transition today is we can go back to basics. We can understand that yes, the Fed has a big blunt tool, but it's incredibly, incredibly effective. The challenge with it is it's like a lot of modern medicine. You take one pill, it might cure this ailment over here, but you might not feel so well, a long way to recovery. And I think again, this Fed just might be able to take that pain in recognizing that we have to get inflation back under control, that would likely come at some expense of the employment side. And it's because we as an economy are just so incredibly strong today that we need to rein in that business cycle. What you said about other central banks, not having the employment mandate, like got me thinking, I'm wondering what the consequences are of that for the US versus other central banks. I would guess you would have, if you're not solely focused on inflation, maybe the US would have more variable inflation, because there's times where I have to deal with higher inflation because of my other mandate. Is that the consequence? Probably, if you're having to do a mandate, is maybe inflation is more variable and you might have to live with higher inflation at times? I don't think so. The way that I would describe it is, look, I think it's quite amazing that they have this dual mandate or even that tri-mandate. I think it's almost asinine to think about a Fed that always has to do something very mechanically. And we can look at other economies around the world today, one of the things the Fed does is they define price stability as core. They want to think about it not in just a sense that there's been the supply shock of high oil prices and we need to immediately react. We need to think step back and say, maybe this won't last forever. And we can focus on the through-cycle view. As for the ECB, it just focuses on that headline inflation number and they were raising rates. And so I really think what it allows the Fed to do is be a bit more forward-looking, a bit more thoughtful in the responses. But a big challenge with that is, in some ways, it's in markets easier to have a Fed that has a pure reaction function. We know the equation, if inflation is high, they're automatically going to raise rates. We know that we do the work for them and we just move on. Because they have hundreds of PhDs on their staff and they still don't know what's going to happen tomorrow. And that's not a fault of the Fed. It's just the reality of the world that we live in. Nobody knows what's going to happen tomorrow. And so I think we need to give them a little bit of grace, but actually I think it makes the US economy way stronger as a result. So taking this from the theory and the practice, how do you think about the situation that Fed finds itself in right now? Before this whole war, they seem to be a little bit more focused on the easing side, a little bit more focused on the employment. Now we have seen inflation. The latest meeting, they seem to be focusing maybe a little bit in the other direction although they haven't made any changes. How do you think about what they should be doing and what they will do in this situation? The first thing that I will say is, we've talked a lot about change, right? The world is always changing. And that's what makes investing so fascinating. It's what keeps us all excited to wake up, at least myself. Every morning is the world is different. And so the world is different in a lot of ways. It's very different for this Fed versus the prior Fed. But for us as investors, if nothing else, warships likely to be very different than Powell. And so we've had this regime change. And one of the most important things that I want to remind everybody and even myself, right? I say it predominantly for myself is, we know coming in and we're told as many times that he is less of a fan of forward guidance. And so everything that he has told us thus far as chairman of the Federal Reserve, he is deliberately trying not to give us a lot of insight into what may happen in the future. Now, it's our jobs to read into that. It's our jobs to make a form views and make opinions on where he ultimately heads. But we have to be very humbles that we're also on that learning journey. So I think where the Fed is today and what maybe the Fed should be doing is exactly at least what I heard from Worsh and that first press conference. The second thing I would say is everything we know about Worsh, and we've got a rich history just given the fact that he's not new to the Fed. I kind of like to equate it in, right? If you go from having friends with kids to having your own kids, becoming a father, all of a sudden you're not a dad and then you are a dad or you're not a mom and then you are a mom. Or for other listeners potentially, you've got a lot of friends that may be married. But then all of a sudden that day you become married, the world just changes. And so everything we know about what Fed, of what Worsh thought the Fed should do, we have to re-question because now it's not what he thinks it should do. It's he gets actually decide what they do. And so that might be different as well. But everything we've heard I think is exactly what should be happening. We have to take the environment that we're in today. We're now five plus years in a period of above-tron inflation. We have to be asking ourselves a very serious question of, no one is worried about runaway inflation today. But at what point after how many years might they be? We know it's not an infinite timeline. But it's apparently more than five years. And so I think the Fed is saying to evolve, we have to probably raise rates if we don't see a direct and obvious path of inflation coming down. And we have to ask ourselves as investors what might lead to that. So the Fed is going to have a reprieve. We're going to see little prices come down just as we've already seen. That will lead into inflation. So we've got a couple of months where inflation will be coming down. But just like the Fed looked through the supply side chalk on the way up, they also have to look through that supply side chalk on the way down. And I think that's exactly what Fed is going to do. I think with technology, that's potentially the savings grace. We've all talked about and heard about that amazing productivity that might come from AI. But I would ask ourselves, are we actually seeing it in our own lives? Because yes, it will come through. But I think it probably comes through over decades. The rise of the computer did not move to an immediately high productivity environment. It happened over the course of a decade and a half. And so I think that's exactly what we're going to see with AI. I think inflation is probably much stronger at the core level. And the Fed is going to raise rates and be willing to sacrifice or accept the consequences of that on the employment market. Do you think there's any lasting impact from the war on inflation? Like we've heard guests who had both sides of this. Some of them said, you know, once it comes back down, we're going to be OK. Others say, you know, oil's inputs to other things. And that's going to still bleed through for a while. And also, if oil prices come down, you might spur demand again. So you might actually get a little bit more inflation that way. Like, do you think there's a lasting impact to this? If you think it's mostly behind us. I mean, the way that I think about it is there's a lasting impact to everything. Everything that we do today, every choice that we make today will ultimately impact how we think about the world tomorrow. And obviously, some things will be far more consequential than others. But I think this war will have lasting impacts. I'm surprised to see where oil prices have on me, it would kind of retrace back to almost pre-war levels. The reality is, is we don't know, at the Middle East, looks like a year from now. We don't know that this 60 days is going to last beyond 60 days. Every single day, there are still headlines that are very contradictory from both sides, the US or Iran. I think what is the most obvious thing that I could say is we're not going back to these act markets in the exact state of the Middle East that we had pre-war. Things will be different. And so in that environment, I absolutely think there are lasting impacts. But even beyond that, what I would say is let's forget about the war. Let's just say it never happened. That was a period where we already had above trend inflation. We, even as last CPI print, we actually had negative goods inflation. We continue to have a challenge with services inflation. And that wasn't impacted by the war. And so if anything, I think oils bleed through to goods prices, maybe had an immediate high impact, and it will come down. But services have completely unchanged. We had a services inflation problem. And Defend note was that. I can make a very credible case. And if I was to put myself on one side of the three places that you just suggested, I think the economy's on incredibly strong footing. It was, if all else equal, the uncertainty of the war, the uncertainty around what might happen in geopolitics, the impact of high-level prices, that made us all maybe pull back our demand function a little bit. And so as we pulled that off, I worry that the end of the war might actually be slightly inflationary rather than disinflationary, at least over the medium term. Just one more, LeSaid. I want to ask you about Worsh and the balance sheet. And I'm not a close Fed watcher, so I could be wrong about this. But I think he believes in a smaller Fed balance sheet. And so I was wondering, do you think that has any impact? You think that's something used to be studied for a long time, and maybe nothing's going to happen in the short term, or do you think there's any impact to that? Well, I'll kind of go back to what I said before. We know what Worsh thought about the balance sheet coming into the Fed. It's yet to be determined what he thinks about the balance sheet as the actual F1 of C-CHA, right? Because the decisions he makes today are very different. Everyone has an opinion on what their boss should be doing, but maybe those opinions are a little different when they actually become the boss. And so look, you're 100% right. Coming in, I think Worsh believes that all else equal we need to think about inflation in two different regimes. You've got goods inflation, and you have asset inflation. And what balance sheet has mostly created is asset price. So if you prop up, if you bring the level of rates down, you buy treasuries, you support the mortgage market, et cetera, all else equal to pushes the level of housing prices up. It impacts the level of stock prices. And so that benefits asset holders, which are broadly that high in compart of population. But what really the Fed is tasked with doing? is preventing price instability or creating price stability for the entirety of the population. And so all else equal, he's created his task force for that. A lot of people ask me what's going to come out of the task force. And the most insightful thing that I honestly can say is that I've never been part of a task force or heard of a task force that comes back says, you know, everything's great, we're not going to do anything. So we're going to get something. And really what I think is likely is the balance sheet over time is going to shrink. Now, I've already said it's not that the Fed cares about financial asset prices directly, but they do care indirectly in the sense that they don't want a financial catastrophe because that would lead to demand destruction and it would lead to a price instability challenge when inflation comes down. So worse is going to be very mindful of that. I think we will step gradually into that reduction. But I think the direction of the balance sheet is it's going to play a smaller role in the US economy, a smaller role in the Fed's arsenal. And if you believe and certainly I do, that it has been a positive force on asset prices, I think we have to ask ourselves the opposite question, what impact will it have on the way down? And I think all else equal. It's just another potential challenge that we have to navigate within markets. Yeah, that point about talking what you're going to do about what you're going to do when you're in the seat and actually doing it is such a good point. And it applies to so many areas of investing. Like all of us say like it marks a 2009, I'll be a hugely aggressive buyer. And then the reality is like put us in the situation in March 2009, like most people are not a hugely aggressive buyer when they see the world collapsing around them. So it's just interesting that it's such an important point. Well, and I'll go back. What drives prices, sentiment drives prices, and sentiment can shift very quickly. And that's it's actually one of the things that I think makes professional investing very different, the personal investing. And I'm obviously an investor and fixed income investor, but the way I run professional portfolios is different than the way I run my portfolios. Because sentiment affects meat directly, right? My own situation, my happiness or lack thereof. But I think that kind of gets back to the question of what world's fixing comes to serve. And I really will go back to we've just been on an incredible dream in the world of equity prices. And so there's all sorts of antidotes. I'm certainly not your first guest to talk about high multiples. We are today running essentially at peak margins. And we have to ask ourselves the question of how sustainable is that capital is taken from labor for a very long time ever since the 1950s. And so ultimately the direction that that has to go is it can't continue on infinitely. It has to continue at some point potentially to reequilibrate. And at what point does labor take from capital and what is the implication as that potentially happens to financial asset prices? I always like to read. I'll leave it up to you if you want to re-answer that without the background. That's totally fine. That's all very, very normal for the podcast. We have all kinds of going to the background. If someone reeled a baby and we'd probably go viral. So I remember that video back in the day. I want to ask you about the national debt because we've gotten all kinds of different opinions on that. I mean, there's been many people panicked about the debt for a very long time. And so far we haven't seen many consequences of it. But we get different opinions. We get some people who say the impact of the debt ultimately is just maybe higher rates and higher inflation over time. And we get other people who talk about debt crises, potentially in the future. So I'm just wondering from your inexperienced income markets. And I'm just wondering what you think about the national debt and what its impact actually is. It's a long question, I know. It's incredibly difficult. It's an incredibly difficult question because we have to think about the impact short term versus long term. I think what it creates is long term, it's unsustainable. I don't think anyone would really push back against that. It's unsustainable. And so eventually it will fix. And the question we have to ask ourselves is does it fix instantaneously in a kind of a giant moment? Probably not. But there's a lot of ways out of our debt crisis. I think we have become very accustomed to running overly expansionary fiscal policies. That's going to have to end. I think we have become accustomed to cutting tax rates on the wealthy, to cutting tax rates on businesses. It's just like when you speak to somebody who may be your friends with and they got an argument with their spouse, you always have to remind yourself that there's two sides of that equation and both sides are probably have some validity to them. And so I think as we look for all of these things that have acted as a tailwind to consumption, two markets, to just the broad economy that we have, are going to become less of a tailwind. And eventually they're going to become a headwind. And that is a tough thing to navigate. And so I don't think it's tremendously challenging to fix income markets in the immediate term. Part of that solution is probably inflation. We've already had a while of that, but you can't have that in perpetuity. And so I do think it has been acting as a steeper on the yield curve. That is to say it's introducing higher uncertainty for longer periods of time. And that longer periods of time just means that rates have to be notably higher on that long end. Obviously we've seen a little bit the opposite here just recently, as we as we ascribe more confidence to that inflation question today with Worsh. But it's having real impacts. And if I was to put it back directly to financial markets, I think really the impact that it's likely to have is that our rates are likely to stay higher for longer than they would have otherwise. And that's exactly what we've seen. And so in a period of rising interest rates, a lot of people are looking at floating rate debt as a potential safe haven. And that's exactly right. But the flip side is that floating rate debt also rolls over, which means those companies have a higher interest burden in their balance sheet equation. And it means that that is a potential source of instability for those companies with a high floating rate component. So I'll look at private credit as potentially one area where that introduces even higher uncertainty. But at the end of the day, I think it's a much more medium to long-term challenge. But it doesn't mean that that medium to long-term challenge doesn't have implications for today. It just means that we're not investing for this kind of regime change or big kaboom type environment. You mentioned private credit. And that's another one we get we get talk about a lot in the podcast. And again, you've got I've asked me all these two-sided questions. But you really do have it. It's another one where you've got people on both sides. I mean, you've got people who some some say private credit is great. And you know, there's been a couple one-off type things that have occurred in there. And other people who think it's a more systemic problem was going on in private credit right now. What do you think about that? Look, private credit is here to stay. And private credit is not new to be fair. It's just been this tremendous flow of capital that has gone into private credit that creates some questions. I think private credit is tremendously valuable in the sense of if you're a small company and you value having a small cohort or even one potential bar or to work with in periods as your business changes, that's exactly what the world of private credit is meant to do. If you're an investor and want to give up liquidity for slightly enhanced return profile, that's another reason why private credit might be great. But at the end of day, private credit is the same as public credit. It's credit. What you have to underwrite is the ability and likelihood that you are going to receive your capital back. And so what we see in private credit is with all of this influx of capital into the private credit area, public market is roughly 65% of the below investment grade is rated double B, which is that highest quality part of the below investment grade. What you have is almost the exact opposite in private credit. Not just to say that your average company borrowing there is just much lower quality. They have much higher leverage. What you have in public credit is you've got about four and a half times free cash flow coverage. What you have in private credit is about two and a half times. And so just as asset classes, the returns on private credit are higher, but it's because the risk is higher. These are less quality companies. And so as I look forward, I think what I would say is we will get a business cycle. That's true for private credit, it's true for public credit, it's true for equities, it's true for everything. And the way that I would think about private credit today is make sure that whoever you might be investing with, you believe in their ability to navigate that business cycle effectively. Because really I think that's what's going to determine individual outcomes. And that's really what we should care about. But private credit is it's valuable, it's here to stay, it serves an important purpose. But it's not always never where better the public credit and vice versa. It's just a compliment and it serves two different purposes. And correct me if I'm wrong, but it would seem like not a great place to index in private credit. It would seem like you want someone who knows what's going on a little bit more than like running like an index type strategy. That makes sense. I think it does. Really what I would say is I think indexing again is also something just different, whether that be in public private, public credit or private credit or equities or not. If you just want broad beta exposure at this point, the private credit market is probably large enough that there are some effective products that can just give you beta exposure. But if you're looking for alpha, I think you want active management. You really want a private credit firm again with that ability to navigate whatever challenges may come their way. Because I think the way that I would think about private and public credit is the intensity of investing becomes much higher when markets are less strong. When you're having to deal with individual situations that as the world changed, aren't working out the way that you want to road them, it just takes more resource, more expertise, more dedicated focus. And so any recently formed private credit shop needs to be thinking about their staffing into the future because eventually they too will have to navigate that credit cycle. Again, my biggest piece of advice is just make sure that you believe in your manager's ability to navigate that credit cycle with the resources, expertise, and knowledge, because eventually they will have to. Just one more for me, we're handed back to Justin. I want to ask you about how you think about managing fixed income portfolios. In my research, I found this thing that you said fixed income should be managed flexibly rather than silos. Can you talk about what that means? Look, I think every investor has to be honest with themselves. As human beings, we'd like to think that we're good at everything and we can do everything, but none of us are. I think as investors, we really have to be honest with ourselves and saying, "What do I bring to the table? What process have I put in place that I can replicate throughout market cycles to act as grounding to how I perform research and how I build portfolios?" The way that I've liked to talk about fixed income markets is a lot of the market is set up for the old world of investing, where there's just these clear delineations between equity and fixed income, public credit and private credit, investment credit and below investment grade, corporate securities and asset back securities. Today, the world is far more complex and we are focusing on outcomes. We're just doing things differently. If we started this conversation with a potential question around AI and CAPEX and so, yes, it's coming in equity markets, yes, it's coming in fixed income markets, yes, it's coming in corporate form and asset back form and CNBS form and it's coming in private markets, it's coming everywhere. Companies these days are tapping markets in all sorts of ways, but we on the asset management side are still very siloed in our thinking. Again, your equity investors, fixed income investors, asset back to investor investors, corporate investors. What I really mean by that and that flexibility is to look across various capital structures and search for relative value because one of the biggest things from my philosophy on fixed income, the most misprice asset in any given point in the cycle actually isn't what might go wrong. The market becomes overly exuberant in pricing volatility or the lack thereof. It's how do I capture a much lower volatility investment today where it doesn't have to cost me in terms of yield and total return today. One of the examples that I like to give is if we said we want to invest in hotels, you could go buy Marriott or Hilton equity, you could go buy corporate bonds, you could buy the time share version and asset back, you could buy an individual property in a CNBS bond, you could buy a pool of properties from a manager who manages a hotel read and each one of those would be focused on by a different analyst and many firms, right, an equity analyst, a CNBS and ABS, a corporate analyst to read analysts, but it's all the same thing. If that hotel operator does well, they all do well, if that hotel operator doesn't or we face a recession, they all do relatively poorly. But the market in any given time will be pricing in the potential upside and downside, but in these periods like we have today and thankfully for the bulk of the market, things are going okay, the economy is doing well and what really that relative value is when you look across those individual silos of fixed income is it allows you to say one of those is going to perform notably better on the downside, but the market's not pricing that today and that's really what I mean by that flexibility is looking across the various asset classes of fixed income because most of the world isn't equipped to do that. And as a result of that, if you put that process in place, to me, it gives you an edge in thinking about how to protect which we've talked about really as a core tenant of being a successful fixed income investor. Jeff, we appreciate your time today. We always like to ask our guests to standard closing questions. The first one is what's the one thing you believe about investing that most of your peers would disagree with you with? Oh gosh, there's a lot. You know, to me, I will go back to something I said earlier. I think the edge that many people in investing really want to hang their hat on is a belief that I can underwrite a company or cash flows. I can know the equity story so much better than anyone else. There's elements of truth to that. There's no shortcut to the hard work of just being a great analyst and understanding what the potential drivers are. But really, what's going to drive that asset price is sentiment? And so I think maybe if I was to answer that question directly, it would be say, you have to focus on what do you think you know, what's priced, what maybe as a price, and how might sentiment intersect with that? It'd be the biggest piece. If I was to answer it may be one other piece and I think we've already talked about that is know yourself. Your sentiment will also shift as the world shifts. And so it might be a great investment, but also know your holding period, your ability to hang on in tough times, your ability to continue to add in, and always give yourself a room to be more wrong. Because as an investor, you will be wrong at times and you always want to have that capacity to step into that. That's great. And then the last one for us is based on your experience in the markets. This is the one lesson you would teach your average investor. And maybe that is the lesson, but if there's something else you'd like to sort of share, that's great too. Well, I guess I kind of preempted that next question. I mean, really, I think that the biggest thing that I would say is, again, you will be challenged. You always want to give yourself to be more wrong. You know, one of my great mentors always used to talk about, he's bought the bottom in many markets. And he's got a lot of stuff he's got to do with the bottom. And he's got a lot of stuff to do with the bottom.