February 2025
Here are some key takeaways from their conversation:
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Hello everyone. And thank you for joining us for another episode of THE FINANCIAL COMMUTE. I'm your host Chris Galeski, joined by Chief Investment Officer Meghan Pinchuk. Meghan, thanks for joining me today.
Thanks for having me.
You know, interest rates seem to be a big topic these days. But they're pivotal in terms of controlling growth or contracting the growth of the economy. And we've been addicted to low interest rates for a long time. And we constantly hear from people these days of like, oh, rates are so high. But that's not really the case.
Not not relative to history, certainly. I think you get a lot of people, including me. I think you not quite to the same extent, but partially you, who grew up in this industry if you're in this industry and rates have always been low. Right. They were declining and then they were zero for a very long time. So now this idea that they're anything other than zero means they're high.
And yeah, from a historical standpoint, not the case.
Right? I mean, the ten year treasuries that what call it four and a half long term over the last 40 years, I think we looked it up and that the average 30 year mortgage is, what, 7.72% over the last 40 years?
Yes. There's been... I mean, even before the fed started lowering rates, there was a lot of talk that oh rates have to come down. They're so high. They're so high. They you know, they must come down. And I think a lot of people assumed that that was what was going to happen. There were there was a lot of preconceived notions about this.
This will occur. And even at one point, I was talking to a mortgage broker about it, and they were urging everyone like, don't lock in any rates because it's coming down. And, you know, again, it's because it was so high. But, you know, it was in the 60s at the time from a historical standpoint, that's actually, you know, again, a little bit below the long term average.
Yeah. Like look, we to your point, we've been spoiled with low interest rates for a really long time. I mean, post-financial crisis, I mean, we had real issues in the economy as it relates to growth. And so the fed sort of needed to do quantitative easing for interest rates to be extremely low, to instill growth, because if you could borrow money at zero, how much are you going to borrow?
All of it.
Right. And then you sort of post 2020 or post Covid, we had inflation and the fed raised interest rates, the highest or the fastest pace that they had in history. And the purpose of that was to slow down the economy because inflation was running too hard.
Yes, they they were behind the curve on the inflation front. One interesting thing too is giving back. You're saying, oh, they were they kept it at zero to stimulate and look post 2008 massive crisis. They emergency measures. They did what they had to do but they kept it at emergency levels for so much longer than we were actually in an emergency, which created, we would argue, the inflation that we're dealing with, you know, today or we're dealing with, we think still dealing with but and so now get me they rose rates two year.
They took rates up to your point to combat that. And then suddenly magically last year they said okay we're going to take it back down again. And inflation had definitely come down at that point. But it wasn't there were still a lot of pressures on that. So it felt a little bit premature. But look, again, higher rates definitely have pressure on real estate, pressure on the economy.
So they said, okay, it's coming down. And then what happens when they dropped rates was actually longer-term rates rose. And that's the first time I think that's happened in modern history.
And so why do you think that happened? I mean, we've got we can speculate. I've got a few thoughts. But I mean it's fascinating to think like everybody was so excited for September of last year. The Fed's going to start lowering interest rates. People that wanted to get a mortgage or borrow money, all of a sudden it didn't get cheaper for them to borrow.
It actually got more expensive. Even though the fed lowered short term interest rates. Why do you think that happened?
This has been something that Jeff, our CEO and I've been talking about for a long time and a real worry, I mean, we've, we've been articulating, but also just when we invest thinking about this concept that the fed does not control interest rates. So the fed is not the bond market. The fed doesn't get to come in and say, oh, we'd like rates to be lower now ten year treasury.
Let's take it down. They only control the very short term rates. And so historically though what you saw is when they took rates down or took them up, the market responded to that. So the bond prices kind of bond interest rates went in the same direction. This was literally a dead opposite move. The fed took interest rates down by a percent, over a few different, cutting cycles.
And then literally the ten year Treasury moved up by approximately the same amount over that period. That's that's kind of, again, unprecedented.
And so when the ten year Treasury moved up borrowing costs for a mortgage or for a loan, it became more expensive for people, even though the fed lowered rates on the short end.
And so everyone's sitting there, you know, counting on banking on the fed, lowering rates. And that was going to cause, you know, cheaper borrowing costs and things like that. That did not transpire. And so there's there's a lot of angst about that now and about kind of going forward, you know, it's what's the fed going to do. But then again, now now the thing that people should be really worried about is how is the bond market going to react?
Because think about why the bond market might move differently from the fed. There's different motivations. The fed wants to take down interest costs even for the federal government, potentially stimulate growth. A bond holder theoretically should be looking at like, what am I going to get paid on this bond? Like, am I going to get paid enough to make this a good investment?
And so you look in and what they're taking you down rates, right. Instead of it being three and a half it moves up to four and a half. That's the bond market telling you that like three and a half or even less in particular, not not enough to lock up your money for ten years because of, because of inflation, right?
Not because there's sort of a big risk that like, they're worried the US government is going to default. It's more like is inflation going to outstrip that three, 3.5% return for a ten year period.
And one of the biggest changes to to that to this cycle of the fed lowering rates on the short end is that now we have a free or market out there in the Treasury world because back in 2020, I look this up, between, 2020 and 2021, the fed was buying $80 billion of U.S. treasuries and $40 billion of mortgage backed securities from banks.
Every single month. That was a huge buyer, forcing like the ten year Treasury to come down as the fed was lowering rates during that 2009 to 2020 cycle. But now the fed is not doing that. And so that's sort of what's caused this. This different move in the short rate is in the short end the Fed's lowering rates.
But then the ten year Treasury's actually going up.
And look if they're going to go in and get and be a buyer. Now you're you're mixing motivation. So you have currently again a more in theory rational but investor who's saying like am I getting paid enough for this inflation risk over this period of time? Does this make sense for me? If the fed comes in and they start being a buyer again, obviously their their motivations are different than that investor.
You talk a lot about making sure that people are getting paid for the risk that they're taking. When it comes to investing.
Yes.
How much do you care about the fed raising or lowering interest rates as it relates to the decisions that you make for our clients?
I don't care at all.
Well, why don't you care?
Well, I don't think you can predict it. So I think there's a lot of people, again, who spend a lot of energy thinking, what's the fed going to do? And then now it's what's the fed going to do? And how is the market going to react to it became more complex in a lot of ways than people had expected over time.
But I just don't think you can know. And I think there's there's a lot of pressure on potential inflation numbers over you know, not maybe a short term period, but more of an intermediate term or long term period. We've got a lot of debt out there, a lot of imbalances. So I don't want anything that I do to be dependent on the fed going up or down on rates.
Right? I don't want it to be like, this is going to be a great investment. If only, you know, fill in the blank. It needs to be good regardless of that. And that's why we've kept things a lot less interest rate sensitive in our portfolios, even with our more traditional bond investments, just because I don't want to be beholden to that.
Yeah. I mean, we were talking the other day about some real estate stuff that, you know, people have shown you and it's like, yeah, this looks great. Assuming rates do go down or if you haven't locked them in, but you're looking at other scenarios, if they haven't locked in rates, how does this actually pan out if rates don't go in your favor?
I, as you can imagine, our investment team gets hundreds of deals across our desk all the time. And it's great because I love to see what's out there, what people are pitching, you know? But number one, you've never seen an investment deck that didn't look great. You know, where the numbers weren't eye popping and exciting. So you have to dig in to like what are their assumptions that go into it.
And very consistently now, real estate deals don't look good unless you're assuming that interest rates eventually come down and you can refinance after a few years at a lower rate. Or when you sell that, the price you're selling at is at a more reasonable rate or your cap rate. And again, all of these things could very well happen.
This is not me making a call and being like, interest rates aren't coming down and real estate prices are going, you know, are aren't going up. It's just that I don't want to enter into a deal where I'm locking in my money for long term right now, where I need that to happen because I don't I don't have a lot of conviction either way in terms of the direction of rates.
I'm glad that you don't have a lot of conviction. I hear so much from, you know, mortgage brokers and real estate agents and other people out there going rates rates are going to come down and they have to look.
And again, it's it's been one of those things where you've had you have people, very smart people anchoring to very low rates for a long time. It's been what a lot of people have known for their whole careers. And so this new paradigm of like rates aren't zero. I think it's hard conceptually for people to grab on to.
But I mean, I remember my my very first mortgage in 2008 was 5.5% that was a screaming deal. Like that was, you know, big discount got I got an awesome deal. And, you know, again, that that was not abnormal. That was not weird. And so the idea that it should be to, you know, is, is something that I think we all anchored to over time, but I think we're not going back there.
I think we're going to have to adjust our I agree if, if I'm, if I'm predicting it's probably not going to do again.
Well, I think, you know, the fact that your first mortgage in 2009 was 5.5% and today it's, you know, call it six and a half to seven, that doesn't seem to out of normal for the range.
Just to correct you it's 2008. And the reason I remember that is because I missed the first-time homeowner credit by I think like a month and a half and I'm not bitter about it still.
So, but, affordability even if rates were five and a half like they were in 2008, affordability is much different because housing prices.
Are so high. And look, we've the reality too is that when we're looking at real estate probably is an investment right now. Real estate's challenge, I mean, real estate is very dependent on interest rates. And so higher rates put pressure on real estate prices from an investment standpoint. So we can talk about that. But but that is a very different experience for anyone who is real estate exposure is their home in Southern California because we've had a complete lack of supply.
Right, all the people who are locked into those beautiful low mortgages, they can't move. I mean, their cost would skyrocket even if they downsize. Their costs are going up. So they're staying put and you have a very low level of supply. And so something comes on the market and people snatch it up. And prices are, you know, at all time highs. So that is again though a very different experience than someone who's even investing in apartment buildings, which have been the darling of real estate for so long.
Real estate now is very local. Specifically, it's the location, location, and that's that's even more so now where certain markets, I think are still going strong. And you could have an apartment building in a great area and your occupancy levels are great, your income's good and it's still growing. And then others that I think there's been too much building, you know, apartments and things like that, too much supply.
And now those prices are getting challenged. It's harder to lease those up and people are having occupancy problems.
I mean, we're in Southern California. Yeah. So we're not the oh, we're not the whole market, but we're seeing something very different here than what we're seeing nationally.
Yes. And again, it's so it's tough for a lot of our clients or local. And so when they're looking at well real estate's doing great. Like probably real estate's not doing great real estate struggling. That doesn't mean you can't have good deals. Like fundamentally we own a lot of real estate where you've got good long term mortgages in place.
Again, they're in decent pockets or markets. Even those though are actually pricing down because interest rates are up. So that that's almost a benchmark where you price things off of. So if you had to go sell today, you would probably get less than you would have a couple of years ago. But if you don't have to sell today and you're getting good cash flow, you can hold on to it.
When thinking about interest rates, like I find it hard to believe that without the fed sort of manipulating the market again by instituting some sort of some sort of quantitative easing or bond buying program, that even if the fed were to lower rates, that borrowing costs are likely to go down. I mean, we have $36 trillion worth of debt that's not getting any better anytime soon.
And so if I'm the fed and I have $36 trillion worth of debt and our interest cost is so expensive, like I kind of want rates to be lower.
There's definitely a motivation in there that, you know, as the other pieces that our current debt levels, our interest levels that we're paying as a, as a country are continuing to go up. But most of our debt, unfortunately, was very short term. So as it matures now, in the next couple of years, we're going to have a bunch of debt that has to get refinanced as a country, and it's going to be a much higher rate.
So our interest cost already exceeds, you know, defense spending. It's going to keep going up, up, up from here based on not even just the increasing the, the debt outstanding. Just, just the interest service cost, which will increase. You know, it's definitely a snowball effect. So I think that there's going to be motivation at some level, you know, for it for interest rates to come lower so that our, our borrowing, our servicing costs on this debt is lower.
To your point, does that mean that the fed has to step in, buy bonds, kind of push things down because rational investors need to get paid more, to take that type of risk? It's very possible.
And what we've seen recently with the fed lowering the short term rates. But then the ten year Treasury and other longer term rates going up, it feels like we're getting back to a little bit of normalcy where, risk is actually being priced in in certain things. And maybe we get to a point where valuations actually matter.
Oh, I, I'm not going to hold my breath. I feel like there's been pockets of time where you say, oh, this this is it. It's going to matter now. Fundamentals are going to drive things again. But we'll see. We'll see. Ultimately there's still a lot of again, motivation to to grow things, to keep things moving. I think we we talked about this before where there's this fear almost at a certain level that like we can't have recessions.
It's like we got to stop. No, no, recessions and recessions suck. But the flip side is it's healthy, too. It lets it lets the poor companies go out of business, but that benefits the other remaining companies and makes them stronger. And I think we have a lot of excess weight as an economy. And look, now they're coming in, right?
And you've got the DOGE.
Department of Government Efficiency.
Yes, Department of Efficiency. And they're going to come in and they're going to cut. And no matter what your political views, I think most people would agree, like not having excess like wasteful spending is a positive thing. That's that's not a controversial, controversial thing to say. The flip side to that is how much can they cut?
Because they're literally like we as a country, we basically take in and revenue about $5 trillion a year, and we spend $7 trillion a year.
That's a big debt to come in and say, I'm going to cut. I'm going to balance the budget. And most of that, by the way, is not discretionary. It's non-discretionary. It's entitlements, things like that, which the current powers have already said they're not going to touch. And you got defense. You know, that that's something where it would be in the current geopolitical environment.
It's hard to imagine them coming in and saying let's cut this drastically. So there is some that's discretionary that theoretically could be cut. But I think it's going to be a little easier said than done.
We've also benefited as an economy for this overspending for quite some time.
We as a country have been, I think, one of the better. And look, the US stock market, but also the US economy has been growing better than most of the rest of the world in recent years. And a lot of that is because of this deficit spending, because we have taken our debt from the of 7 trillion to 36 trillion, that that has resulted in, you know, growth of the economy, where maybe it wouldn't have been if we hadn't been spending at these levels.
So people forget to it's great the idea of like cutting and wasteful spending long term, that's absolutely necessary. It's the right way to go. But short term there's a cost to that there. There would be theoretically an economic pullback. Right. And it's it's that's just that's how the numbers work.
As you as you look at rates being higher today than they were, call it the previous call it 15-16 years. Does that change your mind on on the expected return somebody should get by making long term investment decisions.
I think it's more even almost related to that uncertainty right now. I see long term deals and I mean like, you know, come off your money up for ten years to do this real estate deal or a private investment deal. And, and when you do that, there's got to be, again, a level of confidence that you're going to hit, I think some pretty robust returns.
It's something where there was a lot of we were seeing a lot of relative arguments for a while of like.
You know, before you only could have made 12, but now you can make 14 like, this is this is great. You know, look at, look at on a relative basis. So much better. I think just with the level of uncertainty out there and even the level of potential volatility or uncertainty around interest rates, you need to see some pretty high confidence, robust numbers to lock up money.
That kind of long term today. And I don't think we're seeing it quite yet. We're excited. We're we're kind of watching for opportunities to see what happens. But I'm not feeling anxious to say let's go lock it in because, you know, 14 so amazing versus the 12. It's less of a relative and I think more of an absolute play at this point.
I mean, selfishly, as it relates to giving advice and helping generate income for clients to live their life, this is a much easier environment to live in than 2009 to 2020.
The income deals are good and one piece to on the private lending side, which I think probably anyone who listens with regularity knows is one of our favorite spaces right now. We are finding really great things. For me, a lot of it's floating rate types of deals, but the spread on this type of stuff, I was bigger was wider.
We're making more again, an absolute base now. The spread is narrower than it was when rates were zero, right? When rates were zero. A lot of the stuff to call it 8 to 10. And that was a big spread. That was amazing. Now, you know, with rates having moved up as much as they have, you're yielding, you know, anywhere.
They'll call it like 9 to 12. It depends on the asset class. But there's a lot of different target returns in that space. That have moved up a little bit, but not quite as much as again, the spread hasn't held. And so I think if rates went back down meaningfully, you again might make a little bit less.
But I think there's still going to be that premium, that illiquidity premium that investors are going to demand for, for saying we're looking at money for any period of time. So I think that that space will continue to be attractive. You know, again, you might make a little less on an absolute basis, but I don't worry that rates fall off a cliff and those go down to very little type of thing.
Public markets are different. Like right now you're seeing the spreads, the excess return. You're getting on. Public bonds are really narrow. And so it's something to watch closely. And, you know, for investors who are concerned about that.
And so from an investment perspective, you like having floating rate type instruments. But if you're going to give advice to somebody that's going to take on debt, you'd rather them make sure that they're locking in long term fixed rates. And then if rates come down and they can refinance, then they'll benefit.
But I think you just got a scenario analysis. It's like can you what can you handle. Like if rates move up and you and you're subject to that, can you handle it? Oftentimes the answer is no in those kinds of projects. So I don't think you can I don't think you should be guessing right now with like okay, can which which way are they going to go?
And am I going to make money in either in either scenario. Like if the answer that's yes and you could do okay. And either then then great. You know, take roll the dice a little bit, but otherwise it's just a tough time to be guessing and the outcome being dependent on you being right on that guess.
I mean, my only fear as it relates to interest rates and just sort of where we are as a economy as a whole is we've got tons of debt, so we're devaluing our current dollars. Yes. And if inflation does come back, rates are only likely to go higher. And that's just very challenging.
I will say the perfect scenario from a government standpoint to get out of this debt crisis is I mean, cutting is great and stuff like that. But again, the numbers aren't going to work to that degree where you can actually take this down meaningfully over time. And in my opinion at least, the thing that would be ideal for them.
And even though what you saw after World War two is that actually inflation does run a little hot, you don't want it at 8 or 9% a year. That's when people panic. But like it runs hotter than the Fed's 2% target and they can actually keep interest rates a little below that, which again, not doesn't make sense for a rational investor.
If you have that, then you are, to your point, devaluing your dollar over time. And you're basically now paying back all of this debt with devalued dollars in the future. And that is that is how you get out of this type of a debt situation that is really bad. Like I describe that as like, oh, look, you know, great.
So you devalue the dollar. Like that is really punitive for your economy, for your people. Right? Living there, especially lower income people who are seeing their costs and their grocery bills and things like that go up consistently over time. It's it's a it's a harmful thing to society unless that society is really growing like after World War Two.
That was the scenario. But we had really, really strong growth. So it's almost there was good prosperity. People didn't notice. I think in the current environment, if you entered that again, it'd be sort of death by a thousand cuts to some degree where it's almost what we're seeing now or people are saying, why, you know, I'm making more on an as the nominal basis.
Why aren't, why isn't my my quality of life better essentially. And it's, it's a it's a tough thing to manage.
I mean one other option is to raise taxes and generate more revenue. I mean, inflation and devaluing your dollars is similar to having to pay more in taxes if the dollar stayed strong.
Yeah, different sides of the same coin. I think that's probably not the direction the current regime is. Probably looking to take. But that that's another option. Again, just how much. Because that how how extreme where it's such extreme debt levels. How extreme do you have to get on any of these responses or policies to actually make a dent in a quick, efficient manner?
I don't think that option exists out there. You can do them all at once. But again, no one wants to completely sink the economy. Jim, there's a lot of talk about how in the second Trump administration, things are it's being compared a lot to the first, right? The first one where the stock market was very strong and the economy was reasonably strong.
And so it's great. There's a lot of talk that it's going to continue. This will be even better. It's just we're starting at such a different point, right? From a valuation standpoint, even from a debt standpoint, things are materially more overvalued than they were the last time Trump came into office. And so I think that's going to be tough, like forgetting even him or his policies.
Like, what policies can you have to make a dent on those types of valuation, those types of debt levels? It's a it's a tough situation.
Meghan, I really enjoyed this conversation. I mean, interest rates are a vital part of all the decisions that we make and how it affects our economy and the growth. Obviously, even if the fed was to lower interest rates, we don't know if borrowing costs are actually of come down or go up. But we'll see.
We will see.
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