Episode notes
On the latest episode of WellSaid, fixed income strategist Amar Reganti joins host Thomas Mucha to explore the potential effects of tariffs, ongoing geopolitical conflicts, China's economic recovery, the growth of private credit, and much more on 2025's fixed income markets.
In this episode:
1:55 – History and impact of tariffs
6:15 – Geopolitical conflict and inflation
12:15 – China’s economic recovery
16:00 – US/China great-power conflict
18:45 – Currency risk: Japanese yen
20:00 – US equities: Is it all just one trade?
22:05 – Housing market
24:25 – The growth of private credit
Transcript
THOMAS MUCHA:
2025 is underway, and I can't think of a better way to kick off season four of WellSaid than with today's guest, Amar Reganti, a fixed income strategist and perpetual student of investing, economics, history, and my favorite subject geopolitics. Amar last joined me in 2022 to discuss market volatility, the war in Ukraine, great power competition between the US and China, and the shifting macro, policy, and political landscape. Fast forward to today, and many of those same challenges remain, leaving investors to again wonder what the new year has in store. Regional conflicts continue to smolder. President Trump has stated his intentions to shake up everything from domestic policy to global trade and foreign relations in his second term, and several structural changes in the fixed income markets may affect where capital flows and how it gets there. So a lot to cover, to say the least. Amar, welcome. It's great to have you on WellSaid.
AMAR REGANTI:
Thanks for having me back on Thomas.
THOMAS MUCHA:
So we're going to talk today about the structural underpinnings of fixed income markets and what investors should be thinking about this year. So with Donald Trump recently inaugurated for a second term, let's start there. So if the tariff rhetoric that we're hearing from President Trump becomes trade policy, what might that mean? And particularly if the administration views tariffs as a revenue generator to offset the federal deficit.
AMAR REGANTI:
So tariffs, as a federal revenue generator, like a key part of federal revenue generation, kind of takes us back to the 19th century when, you know, the majority of federal revenues were tariff related. It wasn't until, let's say, the 1870s when southern farmers, who were disproportionately impacted by tariffs because of low crop prices and high input costs, really began agitating for an income tax or replacement for those tariffs. And they were successful, except it was struck down by a 5-4 Supreme Court decision. So, you know, the fight really moved on to getting, a constitutional amendment passed, which happened in 1913. And from that point on, income taxes became a much larger portion. And in fact, the key portion of federal tax revenue.
THOMAS MUCHA:
So the Trump team is playing on history here.
AMAR REGANTI:
So they are looking back to history. And if you note the president kind of continuously cites this late 19th century time period around McKinley. And he's clearly also looking at like, you know, federal tax revenues from that time as well. Now, there's a couple of things at play here in the Trump administration. One is is an extension of the Trump tax cuts, that took place in the first administration. Now, these tax cuts are normally done in ten-year windows. To offset the cost of those tax cuts there has been some discussion about tariff revenue. Now our colleague and friend Mike Medeiros, you know, has done the numbers and believes that that offset could take place if you sort of go on the 50% China tariffs 10% rest of the world. The challenge is, is that once you start instituting tariffs, as you saw, not just in the first Trump administration, but in the early part of the 20th century when we had a lot more tariffs. There tends to be retaliatory tariffs as well. And it also changes human behavior. For example, if you know something is going to be more expensive as a company or an individual, do you start hoarding it? Are there bullwhip effects of supply chains being disrupted or rerouted because of tariffs? What currency are the goods invoiced in? One of the key arguments that Stephen Moran, who's now been nominated to be chair of the CEA in the current administration is that the US dollar would appreciate and offset any kind of tariff pass through for Americans? Well, maybe, but it kind of depends on if the goods are invoiced in dollars or if they're invoiced in foreign currency. If they're invoiced in dollars, a stronger currency doesn't actually necessarily help. And in fact, you know, a stronger dollar could actually widen the trade deficit as well. So, you know, it's very difficult to look at it from a pure, you know, one plus one equals two because there's almost a, you know, a second order impact that can take place. But right now, discussions on the Hill are utilizing tariffs as a revenue filler for the extension of the tax cuts.
THOMAS MUCHA:
How does this play out in the domestic political context? I mean, you gave us an excellent history lesson here. So who are the southern farmers of today?
AMAR REGANTI:
Well, that's a great question to ask. And first of all, the higher the tariffs, the more you need to raise revenue off of them, the more broad based it will be. So like collectively, everyone sort of becomes a southern farmer the higher those tariff rates go. In the near term, this is still kind of being hashed out. Obviously, firms that have to import in inputs for their own, businesses could very well be the southern farmers of today. So, for example, you know, we have a shortage of homes in the United States. And, you know, if Canada is a large provider of lumber and right now, you know, Canada seems to be a particularly specific target in the renegotiation of the US MCA, the Mexico-Canada trade agreement that will likely take place, at some point this year or next. More expensive Canadian lumber obviously has a feed through effect into the ability to complete housing. So we don't know yet because the specific proposals aren't out yet, but you could very easily see how a variety of industries could be impacted, you know, depending upon the tariff levels and who their targeted at.
And you're going to start seeing those industries jocky now, with, you know, their relationships on the Hill to make sure they don't feel like the southern farmers of the 1870s.
THOMAS MUCHA
So a lot of uncertainty, a lot of unintended consequences. Sounds a lot like, my favorite topic of geopolitics. So let's move to that topic. And, you know, my conversations Amar with investors and policymakers are increasingly centered on conflict and its effects on investment outcomes. I mean, military conflict. And to put some perspective on this, we now have 59 active conflicts underway around the world. That's double the number of just five years ago. And it's the worst picture, really since World War two. And conflict, as you know, tends to be inflationary. Hot wars, cold wars, cyber war. Prices can also go up when governments direct spending to defense and national security initiatives. So what do you believe investors should be looking for on this front in 2025? And what, to your mind, are the intersections with central bank efforts to tame stubborn inflation?
AMAR REGANTI
Yeah. No, it's interesting and I don't know, 59 active conflicts, but that's really extraordinary, when you think about it. But, you know, the majority outside of the conflict we see in Ukraine today are what you'd call smaller, contained conflicts. What capital markets haven't experienced, luckily, you know, and I would emphasize that, is what I would call a peer level conflict. And we don't have modern like what I would call data or simulations right now to think about the impact of peer level conflict. We're already seeing competition. Obviously. And the historical precedents for that are all quite negative from an inflationary perspective. No one really thinks about it as much today, but the entire relationship between the US Treasury Department and the Federal Reserve was forged in World War Two and the Korean conflicts on how these institutions, effectively, you know, contributed toward war finance and inflation fighting. So you said it right in the beginning. Conflict is inflationary. But like, we have to ask what about it is the inflationary aspect? Well, especially in peer level conflict, what you're doing is you're taking large segments of your population, some of the most productive workers, and you're taking them away from the manufacturing of things and goods and services. And at the same time, you're channeling real resources away from the everyday consumer goods or things that make standards of living and channeling them more toward conflict. In almost every sort of major upheaval in the last 70 years, we've seen where the US has either been an active participant. World War II, Korea, for example, you know, Vietnam at its sort of peak, 1969 troop strength, or even like not an active participant, but sort of an involved party either through allies and so on, such as the 1973 war in the Middle East or the fall of the Shah of Iran. The US has experienced a wave of inflation from that. In the first examples, it was literally because of the issues we talked about. In the last two examples, it was because a critical import to the US energy at the time had been stymied effectively by this. So and what I find almost disconcerting when I look at it today is those were times, all those periods I mentioned were times where the US was still one of the dominant manufacturers of goods in the world. I mean, even in 1973, the US still primarily had a positive trade balance. Now, obviously its a trade deficit. And over the course of the last 40 or 50 years, we just simply don't have the manufacturing base that we once did. So you could imagine those inflationary effects to be far more severe this time around. And you know what I say this time around, ideally, you know nothing comes to that. But the shockwaves from it in terms of the change in price levels could be much, much more substantial because it would take a long time for the domestic base to reorientate towards manufacturing.
THOMAS MUCHA:
What about the policy implications here? I mean, the examples that you gave are from a long time ago, right? So who's sitting at the Treasury? Who's sitting at the Fed that has these sort of institutional war financing chops?
AMAR REGANTI:
I’m sure both institutions have some, you know, sort of dusty print lying around, but it is not what you would consider top of mind. These are not institutions that over the course of multiple decades, have really been involved in this type of thinking. Indeed, at Treasury for the better part of multiple decades, it was really about, you know, greater promotion of trade, free trade, fair trade. And the idea, of course, was to tighten and have constructive engagement and tighten ties across the world. I don't think that type of thinking has really kind of come into play and that type of, what you'd call centralized coordination that is necessary in these type of environments is really one that that's sort of well drilled out. I used the very historical one of World War II to, there was a yield curve control by the Federal Reserve, literally like interest rates on bond markets couldn't change or move higher because the Federal Reserve capped them. And at the same time, the Treasury Department, the Commerce Department, the Office of Price Administration literally controlled prices and rationing in America. That was an entire, sort of whole of government, whole of society approach. Just seven years later, in the Korean War, there was friction between Treasury and the Federal Reserve, and the roles were sort of split apart. And that sort of became the blueprint of how these institutions operate in the modern world, in this sort of what I would call post Washington consensus world, where we have great power competition, and we have 59 active conflicts. It's very unclear what the institutional dynamics in Washington would be. At that point in time.
THOMAS MUCHA:
Well, no international relations discussion Amar would be complete without China, right? This is central to what we're talking about here. And China, of course, continues to struggle on the macro front, the effect of Beijing's fiscal stimulus has so far been fairly muted. The property bubble in China continues to weigh on growth. Debt is a growing headwind. And, of course, you know, a potential escalating trade war only adds to those challenges. So from your fixed income perspective, what do you think is the main effect of China's painfully slow recovery here?
AMAR REGANTI
So, I like the idea that history, you know, rhymes, not repeats. Right? So when you look at a lot of the current dynamics in China, a good sort of fixed income practitioner's mind goes to Japan in the early 1990s, which was in the throes of a property bubble. And you'd say, oh, wait, it's kind of the same thing. And then, you want to be a little bit more nuanced about it. What's somewhat different about it? Well, the thing that jumps out at me is that despite the slowdown that's taking place in China, they were still able to print about a 5% GDP number, which if you look at Japan during the same time, you know, you'd move to like a negative number. China itself has gone through this reorientation and its property market, which was a very large part of its economy. And yet it was still able to kind of keep growing through this. Now, like Japan, it has engaged in fiscal and monetary stimulus. It was probably slower off the mark. But I had a really interesting discussion with our China strategist, Jonny Yu. And I'd asked him like, what lessons do you think policymakers in Beijing and the PBoC took away from Japan? And I said, doesn't the 1990s resonate? And he says, and I'm paraphrasing here, the 1990s does resonate, but really it's also the late 1980s for Japan. And one of the primary goals of the Chinese policymaking community is making sure that a speculative bubble has burst and sort of deflated, but at the same time maintaining dominant sort of technological progression for Chinese industry to still remain a dominant manufacturer and to increase productivity. So what China does not necessarily want to do is say, let's wholly reorient toward the consumption model, and let some of what we would call, you know, overcapacity issues effectively, like retreat or shrink. That is not in the long-term planning of the policymaking community. So instead, what they're looking to do is what we would call here foam the runway, which is to make this transition less painful in various degrees. For example, civil service pay was just increased in China to help reboost consumption. But at the same time continue the export dominance that they have, because from their perspective, it's better to be able to make the things to have the stuff right. It gives you a lot more optionality, both economically and politically. And that is continuing. And from a fixed income perspective, it's primarily deflationary. I mean, Chinese bond yields have moved down 90 basis points in over the course of a year. If you look at their ten rates, that’s showing much, much slower growth. At the same time, if you're leaning into an export orientated model, it means you want to give the world more things. Right. And by definition, those things are going to be cheaper now. So, the perspective is that they looked at Japan, they understood you know, that Japan had a balance sheet recession. They were attempting to fight against it, but at the same time, don't want to lose the edge in the set of industries that they've determined are critical for China's future.
THOMAS MUCHA:
How much leverage does the Trump administration have over the Chinese economy, given that delicate balance that you just laid out? I mean, can significant tariffs knock China off of that economic path?
AMAR REGANTI:
So if you've created one of the world's largest factory floors effectively, like it's very hard to derail that, right? You might be operating at margins that from a markets perspective, you don't find attractive or a return on equity investment you don't find necessarily attractive. But that doesn't mean you're going to stop doing it. I think it's a lot harder. And remember, it sort of takes two to tango here. China embarked on this massive industrialization and manufacturing capability while the US, over the course of 30 or 40 years, in a bipartisan way, had embarked on a trade orientated, foreign and trade policy. The Trump administration, trying to use tariffs, trying to formulate an industrial policy for the United States, that's very hard to do in just a couple of years. To even recapture a portion of that is what I would call a generational endeavor. Right. And generational endeavors in America rarely occur with what I would call one party sort of championing it. There almost always has to be a bipartisan push for that, because it takes a long time. Otherwise, when elections or Congress turns over, all of a sudden all those things fall by the wayside.
THOMAS MUCHA:
Now, there is bipartisan agreement about China as a national security threat. Do you think that's possible to carry over in an extended period into the economic and trade realm?
AMAR REGANTI:
So there may be a bipartisan sort of consideration of that. Thus far, it seems to really focus on specific key national security orientated industries, you know, artificial intelligence, you know, chips, for example. But if you think about industrial capacity, it's about all kinds of things. Right? It's about the ability to have abundance despite the prevailing conditions happening around the world. So yes, you can have those things, but think about the 3 million things you use in any given year that aren't important for national security, but important to the quality of life that you as a member of society and a citizen get. I really think that we think about this in national security terms, and that's an important lens. But national security is not just about making the things to win what you call peer level conflict. It's about being able to maintain some standard of living in the face of prolonged competition around the world. And the inability to do that really is very challenging in the sort of new world.
THOMAS MUCHA:
So currencies are a big part of what you just mentioned, Amar. And, you know, I want to move specifically to the Japanese yen for a moment. Last summer's yen carry trade unwind was a shock to markets that had some unexpected consequences, including a selloff in US tech stocks and a decline in US Treasury yields. So what do you see happening this time around if the Bank of Japan again hikes rates to stem inflation?
AMAR REGANTI:
Well, I think now at least there's been pretty good telegraphing by the BoJ that at some point, even though there's been a little bit of a delay, that these rates are moving up. I think what had happened was over the course of a number of years, a carry trade can be defined in a number of ways, but the most common way is you borrow on a low interest rate currency, you invest in the high interest rate currency. And as long as there's not a lot of volatility, you know, things should be fine. And of course, when the unexpected happens or volatility happens, all these things have to unwind. And they often unwind around the same time, heightening that volatility. I think people are far more aware of that. That doesn't mean there aren't hidden air pockets. But to some degree, I think the pain of that, over the course of that time was substantial enough that some of that has been really, really unwound.
THOMAS MUCHA:
There's a live and learn aspect here.
AMAR REGANTI:
One would think. And Hyman Minsky, the famed economist would say that there was these little there's a Minsky moment. Right. Which is lack of volatility leads to leverage on a trade. And then the unexpected happens. And all of that unwinds.
THOMAS MUCHA:
So you know moving to equities, Amar. What would the fallout be for fixed income in the event of a reversal of the two-year US equity market rally, which has, of course, been fueled by this stunning run up of large cap tech stocks?
AMAR REGANTI:
One is obviously I think it would cause a flight to quality to some degree. And a lot of the talk you hear about higher rates would all of a sudden, you know, become a little bit deflated as interest rates moved, you know, rapidly downward to offset this risk off event. But I think the implications could be a bit bigger. So Kyra Fecteau, my colleague who specializes in securitized credit, and the US consumer brought up this interesting point that there's a cohort of the US population, you know, the wealthiest cohort that has never had a larger equity holding as a percentage of their total assets until right now. And that's including going back to the dot com bubble. So you ask, how can people make all cash offers in an era of 7% mortgage rates? Right. Well, the answer is they have this store of wealth that allows them to do this. If you look at things like home buying, you notice the average age has moved up into the 50s. Some of these folks have bought multiple times, all of which kind of moves you away from the first-time buying cohort and far more into the wealthier cohort. Well, it is an interesting question to ask: Is it all just one trade? Meaning is it just an equity market run up that has allowed so many other asset classes to stay elevated, including things like housing and so on? If that is true, and I think it takes a lot more academic, you know, work and work here on the floor to really discern that. That means there's other parts of the economy that would be vulnerable just because of an equity selloff. And that's why it's always interesting to ask, is there just one trade and everything is connected to that? From a high-quality fixed income perspective, that sell off would be - it sounds grim – positive as people look for their return and safety and liquidity in the higher quality fixed income market.
THOMAS MUCHA:
Yeah. So it's the trade off of that.
AMAR REGANTI:
Yeah.
THOMAS MUCHA:
So, Amar, you just brought up the housing market, and we are again hearing rumors of Republican plans to reform Fannie Mae and Freddie Mac, the US government sponsored enterprises that support the US housing and mortgage markets. Now, privatizing these entities has been tried before, or at least it's been discussed being tried before. But the fundamental risk proved too great. So why do you think this is coming up again in Washington? And what do you anticipate happening this time around?
AMAR REGANTI:
So in the first Trump administration, the director of the FHFA, which is the federal agency that that oversees Fannie Mae and Freddie Mac, actually pushed quite hard to privatize these entities or move them away from the current conservatorship model that FHFA and the Treasury Department have over them. And he really started, I think, moving aggressively near the end of that first administration and didn't have enough time. Well, there's four years now, and that increases the chances that those two institutions could, you know, move out of conservatorship. But there's so many unanswered questions that need to take place. Right. What does it mean for Treasury's preferred stock holdings, which are like some several hundred billion dollars’ worth? Would the government still be the majority shareholder in these institutions? What type of credit or guarantees will the government offer? And this is important because for all intents and purposes, these two institutions, along with the Ginny Mae, which is not under conservatorship, provide the financing and backing for the 30-year mortgage, which is the linchpin, the backbone of the US housing market. So rushing these institutions out of conservatorship without a lot of questions being answered, has a chance of making already expensive home financing even more expensive. So, it's very possible, from the perspective of the new administration, that this is what they want to do, but I think there's going to be a pretty substantial checklist to work through. And it would be very volatile if sort of the due diligence wasn't done ahead of time. And they have four years. So like, you know, you have time to actually work on this versus like rushing it out.
THOMAS MUCHA:
All right, Amar, I'd like to wrap up this conversation on the topic of the rise of private credit. Now, I've heard you refer to this growing market as a new massive shadow bank. So with that in mind, what's the good, bad and the ugly with regard to private credit markets and what should investors be thinking about in the near term?
AMAR REGANTI:
So when I say, you know, a new massive shadow bank that seems to come out automatically as a bad thing. And that's not how I meant it. What I meant was that there's another channel in the US economy, a credit creating channel, that is doing a lot of the work that was traditionally done by banks. It plays a very important role in the broader economy. In 2023, when we had the bank run at SVB and First Republic, lending conditions in other institutions started tightening like right away. And it makes sense. Right. You're a senior loan officer. You see your peer institutions in trouble. You really do think about hauling back. All of a sudden your regulators are showing up and asking, hey, why don't we talk about what's going on in your own institution. That makes you naturally conservative through that type of volatility. Private credit didn't miss a beat. It just kept fundraising and growing during that period of time. And the benefits are substantial. It matches assets and liabilities a little bit closer. Right. Like while banks like SVB suffered a bank run, that's very difficult, if not impossible to do in a typical private credit fund. The fact that it's done sort of by these investors allows more customized loans, the ability to change terms to sort of meet the underlying business. All of these things are like, that’s very good. Right? It's a robust kind of model. Now also it you know for the beginning part of it, it really was kind of kept away from what you'd call like the regulated balance sheets of banks. And that was good too, because in case something went wrong, it doesn't bleed into the broader economy as quickly. Well, the challenges now are that it's grown dramatically. Like the IMF estimates, it's around $2 trillion in AUM. And, you know, there's not a ton of transparency in it. You know, it's slightly different than, let's say, a commercial bank where, you know, the regulator comes in, the bank examiner and it's like, okay, well, why do you have so much, you know, CMBS or commercial loan exposure or resi exposure and like, there's ways you can sort of make that bank a safer, sounder entity. So the transparency that would normally come with what I'll call prudential regulation, just, you know, it's not there. Doesn't mean something bad is happening. It's just not there yet. And, you know, it would benefit investors, capital markets participants to have more data. Now part of the challenges, it's linking back now into what I'll call the regulated sector. So there are things called CFOs collateralized fund obligations. Right. Which is I see your eyebrows going up as I use an acronym on this one, but it's effectively, you know, banks and regulated entities taking a number of these funds, pooling them, and then allowing instead of you becoming an LP in these funds, you could buy a tranche of these funds. And, you know, there's what you'd call rated entities where it's targeted toward rating sensitive buyers. So a lot of ones structuring friends are very busy. And again, like it behooves all of us to want more insight into that because now it's starting to really be held and bought, risk exposure and various ways to parts of the banking and insurance structure. And again, not necessarily a bad thing, but this is where having a sense of the linkages, understanding the sizes, the AUM, all of these things and the underlying quality of the assets, it's important. Generally the sunlight is a good thing in all of these.
THOMAS MUCHA:
All right, Amar, I want to thank you for the time that you spent with us here today. We covered a lot of ground. And it was all fascinating. Once again Amar Reganti, fixed income strategist here at Wellington. Thanks for being with us on WellSaid.
AMAR REGANTI:
Thanks a lot. Thanks for having me, Thomas.
THOMAS MUCHA:
2025 is underway, and I can't think of a better way to kick off season four of WellSaid than with today's guest, Amar Reganti, a fixed income strategist and perpetual student of investing, economics, history, and my favorite subject geopolitics. Amar last joined me in 2022 to discuss market volatility, the war in Ukraine, great power competition between the US and China, and the shifting macro, policy, and political landscape. Fast forward to today, and many of those same challenges remain, leaving investors to again wonder what the new year has in store. Regional conflicts continue to smolder. President Trump has stated his intentions to shake up everything from domestic policy to global trade and foreign relations in his second term, and several structural changes in the fixed income markets may affect where capital flows and how it gets there. So a lot to cover, to say the least. Amar, welcome. It's great to have you on WellSaid.
AMAR REGANTI:
Thanks for having me back on Thomas.
THOMAS MUCHA:
So we're going to talk today about the structural underpinnings of fixed income markets and what investors should be thinking about this year. So with Donald Trump recently inaugurated for a second term, let's start there. So if the tariff rhetoric that we're hearing from President Trump becomes trade policy, what might that mean? And particularly if the administration views tariffs as a revenue generator to offset the federal deficit.
AMAR REGANTI:
So tariffs, as a federal revenue generator, like a key part of federal revenue generation, kind of takes us back to the 19th century when, you know, the majority of federal revenues were tariff related. It wasn't until, let's say, the 1870s when southern farmers, who were disproportionately impacted by tariffs because of low crop prices and high input costs, really began agitating for an income tax or replacement for those tariffs. And they were successful, except it was struck down by a 5-4 Supreme Court decision. So, you know, the fight really moved on to getting, a constitutional amendment passed, which happened in 1913. And from that point on, income taxes became a much larger portion. And in fact, the key portion of federal tax revenue.
THOMAS MUCHA:
So the Trump team is playing on history here.
AMAR REGANTI:
So they are looking back to history. And if you note the president kind of continuously cites this late 19th century time period around McKinley. And he's clearly also looking at like, you know, federal tax revenues from that time as well. Now, there's a couple of things at play here in the Trump administration. One is is an extension of the Trump tax cuts, that took place in the first administration. Now, these tax cuts are normally done in ten-year windows. To offset the cost of those tax cuts there has been some discussion about tariff revenue. Now our colleague and friend Mike Medeiros, you know, has done the numbers and believes that that offset could take place if you sort of go on the 50% China tariffs 10% rest of the world. The challenge is, is that once you start instituting tariffs, as you saw, not just in the first Trump administration, but in the early part of the 20th century when we had a lot more tariffs. There tends to be retaliatory tariffs as well. And it also changes human behavior. For example, if you know something is going to be more expensive as a company or an individual, do you start hoarding it? Are there bullwhip effects of supply chains being disrupted or rerouted because of tariffs? What currency are the goods invoiced in? One of the key arguments that Stephen Moran, who's now been nominated to be chair of the CEA in the current administration is that the US dollar would appreciate and offset any kind of tariff pass through for Americans? Well, maybe, but it kind of depends on if the goods are invoiced in dollars or if they're invoiced in foreign currency. If they're invoiced in dollars, a stronger currency doesn't actually necessarily help. And in fact, you know, a stronger dollar could actually widen the trade deficit as well. So, you know, it's very difficult to look at it from a pure, you know, one plus one equals two because there's almost a, you know, a second order impact that can take place. But right now, discussions on the Hill are utilizing tariffs as a revenue filler for the extension of the tax cuts.
THOMAS MUCHA:
How does this play out in the domestic political context? I mean, you gave us an excellent history lesson here. So who are the southern farmers of today?
AMAR REGANTI:
Well, that's a great question to ask. And first of all, the higher the tariffs, the more you need to raise revenue off of them, the more broad based it will be. So like collectively, everyone sort of becomes a southern farmer the higher those tariff rates go. In the near term, this is still kind of being hashed out. Obviously, firms that have to import in inputs for their own, businesses could very well be the southern farmers of today. So, for example, you know, we have a shortage of homes in the United States. And, you know, if Canada is a large provider of lumber and right now, you know, Canada seems to be a particularly specific target in the renegotiation of the US MCA, the Mexico-Canada trade agreement that will likely take place, at some point this year or next. More expensive Canadian lumber obviously has a feed through effect into the ability to complete housing. So we don't know yet because the specific proposals aren't out yet, but you could very easily see how a variety of industries could be impacted, you know, depending upon the tariff levels and who their targeted at.
And you're going to start seeing those industries jocky now, with, you know, their relationships on the Hill to make sure they don't feel like the southern farmers of the 1870s.
THOMAS MUCHA
So a lot of uncertainty, a lot of unintended consequences. Sounds a lot like, my favorite topic of geopolitics. So let's move to that topic. And, you know, my conversations Amar with investors and policymakers are increasingly centered on conflict and its effects on investment outcomes. I mean, military conflict. And to put some perspective on this, we now have 59 active conflicts underway around the world. That's double the number of just five years ago. And it's the worst picture, really since World War two. And conflict, as you know, tends to be inflationary. Hot wars, cold wars, cyber war. Prices can also go up when governments direct spending to defense and national security initiatives. So what do you believe investors should be looking for on this front in 2025? And what, to your mind, are the intersections with central bank efforts to tame stubborn inflation?
AMAR REGANTI
Yeah. No, it's interesting and I don't know, 59 active conflicts, but that's really extraordinary, when you think about it. But, you know, the majority outside of the conflict we see in Ukraine today are what you'd call smaller, contained conflicts. What capital markets haven't experienced, luckily, you know, and I would emphasize that, is what I would call a peer level conflict. And we don't have modern like what I would call data or simulations right now to think about the impact of peer level conflict. We're already seeing competition. Obviously. And the historical precedents for that are all quite negative from an inflationary perspective. No one really thinks about it as much today, but the entire relationship between the US Treasury Department and the Federal Reserve was forged in World War Two and the Korean conflicts on how these institutions, effectively, you know, contributed toward war finance and inflation fighting. So you said it right in the beginning. Conflict is inflationary. But like, we have to ask what about it is the inflationary aspect? Well, especially in peer level conflict, what you're doing is you're taking large segments of your population, some of the most productive workers, and you're taking them away from the manufacturing of things and goods and services. And at the same time, you're channeling real resources away from the everyday consumer goods or things that make standards of living and channeling them more toward conflict. In almost every sort of major upheaval in the last 70 years, we've seen where the US has either been an active participant. World War II, Korea, for example, you know, Vietnam at its sort of peak, 1969 troop strength, or even like not an active participant, but sort of an involved party either through allies and so on, such as the 1973 war in the Middle East or the fall of the Shah of Iran. The US has experienced a wave of inflation from that. In the first examples, it was literally because of the issues we talked about. In the last two examples, it was because a critical import to the US energy at the time had been stymied effectively by this. So and what I find almost disconcerting when I look at it today is those were times, all those periods I mentioned were times where the US was still one of the dominant manufacturers of goods in the world. I mean, even in 1973, the US still primarily had a positive trade balance. Now, obviously its a trade deficit. And over the course of the last 40 or 50 years, we just simply don't have the manufacturing base that we once did. So you could imagine those inflationary effects to be far more severe this time around. And you know what I say this time around, ideally, you know nothing comes to that. But the shockwaves from it in terms of the change in price levels could be much, much more substantial because it would take a long time for the domestic base to reorientate towards manufacturing.
THOMAS MUCHA:
What about the policy implications here? I mean, the examples that you gave are from a long time ago, right? So who's sitting at the Treasury? Who's sitting at the Fed that has these sort of institutional war financing chops?
AMAR REGANTI:
I’m sure both institutions have some, you know, sort of dusty print lying around, but it is not what you would consider top of mind. These are not institutions that over the course of multiple decades, have really been involved in this type of thinking. Indeed, at Treasury for the better part of multiple decades, it was really about, you know, greater promotion of trade, free trade, fair trade. And the idea, of course, was to tighten and have constructive engagement and tighten ties across the world. I don't think that type of thinking has really kind of come into play and that type of, what you'd call centralized coordination that is necessary in these type of environments is really one that that's sort of well drilled out. I used the very historical one of World War II to, there was a yield curve control by the Federal Reserve, literally like interest rates on bond markets couldn't change or move higher because the Federal Reserve capped them. And at the same time, the Treasury Department, the Commerce Department, the Office of Price Administration literally controlled prices and rationing in America. That was an entire, sort of whole of government, whole of society approach. Just seven years later, in the Korean War, there was friction between Treasury and the Federal Reserve, and the roles were sort of split apart. And that sort of became the blueprint of how these institutions operate in the modern world, in this sort of what I would call post Washington consensus world, where we have great power competition, and we have 59 active conflicts. It's very unclear what the institutional dynamics in Washington would be. At that point in time.
THOMAS MUCHA:
Well, no international relations discussion Amar would be complete without China, right? This is central to what we're talking about here. And China, of course, continues to struggle on the macro front, the effect of Beijing's fiscal stimulus has so far been fairly muted. The property bubble in China continues to weigh on growth. Debt is a growing headwind. And, of course, you know, a potential escalating trade war only adds to those challenges. So from your fixed income perspective, what do you think is the main effect of China's painfully slow recovery here?
AMAR REGANTI
So, I like the idea that history, you know, rhymes, not repeats. Right? So when you look at a lot of the current dynamics in China, a good sort of fixed income practitioner's mind goes to Japan in the early 1990s, which was in the throes of a property bubble. And you'd say, oh, wait, it's kind of the same thing. And then, you want to be a little bit more nuanced about it. What's somewhat different about it? Well, the thing that jumps out at me is that despite the slowdown that's taking place in China, they were still able to print about a 5% GDP number, which if you look at Japan during the same time, you know, you'd move to like a negative number. China itself has gone through this reorientation and its property market, which was a very large part of its economy. And yet it was still able to kind of keep growing through this. Now, like Japan, it has engaged in fiscal and monetary stimulus. It was probably slower off the mark. But I had a really interesting discussion with our China strategist, Jonny Yu. And I'd asked him like, what lessons do you think policymakers in Beijing and the PBoC took away from Japan? And I said, doesn't the 1990s resonate? And he says, and I'm paraphrasing here, the 1990s does resonate, but really it's also the late 1980s for Japan. And one of the primary goals of the Chinese policymaking community is making sure that a speculative bubble has burst and sort of deflated, but at the same time maintaining dominant sort of technological progression for Chinese industry to still remain a dominant manufacturer and to increase productivity. So what China does not necessarily want to do is say, let's wholly reorient toward the consumption model, and let some of what we would call, you know, overcapacity issues effectively, like retreat or shrink. That is not in the long-term planning of the policymaking community. So instead, what they're looking to do is what we would call here foam the runway, which is to make this transition less painful in various degrees. For example, civil service pay was just increased in China to help reboost consumption. But at the same time continue the export dominance that they have, because from their perspective, it's better to be able to make the things to have the stuff right. It gives you a lot more optionality, both economically and politically. And that is continuing. And from a fixed income perspective, it's primarily deflationary. I mean, Chinese bond yields have moved down 90 basis points in over the course of a year. If you look at their ten rates, that’s showing much, much slower growth. At the same time, if you're leaning into an export orientated model, it means you want to give the world more things. Right. And by definition, those things are going to be cheaper now. So, the perspective is that they looked at Japan, they understood you know, that Japan had a balance sheet recession. They were attempting to fight against it, but at the same time, don't want to lose the edge in the set of industries that they've determined are critical for China's future.
THOMAS MUCHA:
How much leverage does the Trump administration have over the Chinese economy, given that delicate balance that you just laid out? I mean, can significant tariffs knock China off of that economic path?
AMAR REGANTI:
So if you've created one of the world's largest factory floors effectively, like it's very hard to derail that, right? You might be operating at margins that from a markets perspective, you don't find attractive or a return on equity investment you don't find necessarily attractive. But that doesn't mean you're going to stop doing it. I think it's a lot harder. And remember, it sort of takes two to tango here. China embarked on this massive industrialization and manufacturing capability while the US, over the course of 30 or 40 years, in a bipartisan way, had embarked on a trade orientated, foreign and trade policy. The Trump administration, trying to use tariffs, trying to formulate an industrial policy for the United States, that's very hard to do in just a couple of years. To even recapture a portion of that is what I would call a generational endeavor. Right. And generational endeavors in America rarely occur with what I would call one party sort of championing it. There almost always has to be a bipartisan push for that, because it takes a long time. Otherwise, when elections or Congress turns over, all of a sudden all those things fall by the wayside.
THOMAS MUCHA:
Now, there is bipartisan agreement about China as a national security threat. Do you think that's possible to carry over in an extended period into the economic and trade realm?
AMAR REGANTI:
So there may be a bipartisan sort of consideration of that. Thus far, it seems to really focus on specific key national security orientated industries, you know, artificial intelligence, you know, chips, for example. But if you think about industrial capacity, it's about all kinds of things. Right? It's about the ability to have abundance despite the prevailing conditions happening around the world. So yes, you can have those things, but think about the 3 million things you use in any given year that aren't important for national security, but important to the quality of life that you as a member of society and a citizen get. I really think that we think about this in national security terms, and that's an important lens. But national security is not just about making the things to win what you call peer level conflict. It's about being able to maintain some standard of living in the face of prolonged competition around the world. And the inability to do that really is very challenging in the sort of new world.
THOMAS MUCHA:
So currencies are a big part of what you just mentioned, Amar. And, you know, I want to move specifically to the Japanese yen for a moment. Last summer's yen carry trade unwind was a shock to markets that had some unexpected consequences, including a selloff in US tech stocks and a decline in US Treasury yields. So what do you see happening this time around if the Bank of Japan again hikes rates to stem inflation?
AMAR REGANTI:
Well, I think now at least there's been pretty good telegraphing by the BoJ that at some point, even though there's been a little bit of a delay, that these rates are moving up. I think what had happened was over the course of a number of years, a carry trade can be defined in a number of ways, but the most common way is you borrow on a low interest rate currency, you invest in the high interest rate currency. And as long as there's not a lot of volatility, you know, things should be fine. And of course, when the unexpected happens or volatility happens, all these things have to unwind. And they often unwind around the same time, heightening that volatility. I think people are far more aware of that. That doesn't mean there aren't hidden air pockets. But to some degree, I think the pain of that, over the course of that time was substantial enough that some of that has been really, really unwound.
THOMAS MUCHA:
There's a live and learn aspect here.
AMAR REGANTI:
One would think. And Hyman Minsky, the famed economist would say that there was these little there's a Minsky moment. Right. Which is lack of volatility leads to leverage on a trade. And then the unexpected happens. And all of that unwinds.
THOMAS MUCHA:
So you know moving to equities, Amar. What would the fallout be for fixed income in the event of a reversal of the two-year US equity market rally, which has, of course, been fueled by this stunning run up of large cap tech stocks?
AMAR REGANTI:
One is obviously I think it would cause a flight to quality to some degree. And a lot of the talk you hear about higher rates would all of a sudden, you know, become a little bit deflated as interest rates moved, you know, rapidly downward to offset this risk off event. But I think the implications could be a bit bigger. So Kyra Fecteau, my colleague who specializes in securitized credit, and the US consumer brought up this interesting point that there's a cohort of the US population, you know, the wealthiest cohort that has never had a larger equity holding as a percentage of their total assets until right now. And that's including going back to the dot com bubble. So you ask, how can people make all cash offers in an era of 7% mortgage rates? Right. Well, the answer is they have this store of wealth that allows them to do this. If you look at things like home buying, you notice the average age has moved up into the 50s. Some of these folks have bought multiple times, all of which kind of moves you away from the first-time buying cohort and far more into the wealthier cohort. Well, it is an interesting question to ask: Is it all just one trade? Meaning is it just an equity market run up that has allowed so many other asset classes to stay elevated, including things like housing and so on? If that is true, and I think it takes a lot more academic, you know, work and work here on the floor to really discern that. That means there's other parts of the economy that would be vulnerable just because of an equity selloff. And that's why it's always interesting to ask, is there just one trade and everything is connected to that? From a high-quality fixed income perspective, that sell off would be - it sounds grim – positive as people look for their return and safety and liquidity in the higher quality fixed income market.
THOMAS MUCHA:
Yeah. So it's the trade off of that.
AMAR REGANTI:
Yeah.
THOMAS MUCHA:
So, Amar, you just brought up the housing market, and we are again hearing rumors of Republican plans to reform Fannie Mae and Freddie Mac, the US government sponsored enterprises that support the US housing and mortgage markets. Now, privatizing these entities has been tried before, or at least it's been discussed being tried before. But the fundamental risk proved too great. So why do you think this is coming up again in Washington? And what do you anticipate happening this time around?
AMAR REGANTI:
So in the first Trump administration, the director of the FHFA, which is the federal agency that that oversees Fannie Mae and Freddie Mac, actually pushed quite hard to privatize these entities or move them away from the current conservatorship model that FHFA and the Treasury Department have over them. And he really started, I think, moving aggressively near the end of that first administration and didn't have enough time. Well, there's four years now, and that increases the chances that those two institutions could, you know, move out of conservatorship. But there's so many unanswered questions that need to take place. Right. What does it mean for Treasury's preferred stock holdings, which are like some several hundred billion dollars’ worth? Would the government still be the majority shareholder in these institutions? What type of credit or guarantees will the government offer? And this is important because for all intents and purposes, these two institutions, along with the Ginny Mae, which is not under conservatorship, provide the financing and backing for the 30-year mortgage, which is the linchpin, the backbone of the US housing market. So rushing these institutions out of conservatorship without a lot of questions being answered, has a chance of making already expensive home financing even more expensive. So, it's very possible, from the perspective of the new administration, that this is what they want to do, but I think there's going to be a pretty substantial checklist to work through. And it would be very volatile if sort of the due diligence wasn't done ahead of time. And they have four years. So like, you know, you have time to actually work on this versus like rushing it out.
THOMAS MUCHA:
All right, Amar, I'd like to wrap up this conversation on the topic of the rise of private credit. Now, I've heard you refer to this growing market as a new massive shadow bank. So with that in mind, what's the good, bad and the ugly with regard to private credit markets and what should investors be thinking about in the near term?
AMAR REGANTI:
So when I say, you know, a new massive shadow bank that seems to come out automatically as a bad thing. And that's not how I meant it. What I meant was that there's another channel in the US economy, a credit creating channel, that is doing a lot of the work that was traditionally done by banks. It plays a very important role in the broader economy. In 2023, when we had the bank run at SVB and First Republic, lending conditions in other institutions started tightening like right away. And it makes sense. Right. You're a senior loan officer. You see your peer institutions in trouble. You really do think about hauling back. All of a sudden your regulators are showing up and asking, hey, why don't we talk about what's going on in your own institution. That makes you naturally conservative through that type of volatility. Private credit didn't miss a beat. It just kept fundraising and growing during that period of time. And the benefits are substantial. It matches assets and liabilities a little bit closer. Right. Like while banks like SVB suffered a bank run, that's very difficult, if not impossible to do in a typical private credit fund. The fact that it's done sort of by these investors allows more customized loans, the ability to change terms to sort of meet the underlying business. All of these things are like, that’s very good. Right? It's a robust kind of model. Now also it you know for the beginning part of it, it really was kind of kept away from what you'd call like the regulated balance sheets of banks. And that was good too, because in case something went wrong, it doesn't bleed into the broader economy as quickly. Well, the challenges now are that it's grown dramatically. Like the IMF estimates, it's around $2 trillion in AUM. And, you know, there's not a ton of transparency in it. You know, it's slightly different than, let's say, a commercial bank where, you know, the regulator comes in, the bank examiner and it's like, okay, well, why do you have so much, you know, CMBS or commercial loan exposure or resi exposure and like, there's ways you can sort of make that bank a safer, sounder entity. So the transparency that would normally come with what I'll call prudential regulation, just, you know, it's not there. Doesn't mean something bad is happening. It's just not there yet. And, you know, it would benefit investors, capital markets participants to have more data. Now part of the challenges, it's linking back now into what I'll call the regulated sector. So there are things called CFOs collateralized fund obligations. Right. Which is I see your eyebrows going up as I use an acronym on this one, but it's effectively, you know, banks and regulated entities taking a number of these funds, pooling them, and then allowing instead of you becoming an LP in these funds, you could buy a tranche of these funds. And, you know, there's what you'd call rated entities where it's targeted toward rating sensitive buyers. So a lot of ones structuring friends are very busy. And again, like it behooves all of us to want more insight into that because now it's starting to really be held and bought, risk exposure and various ways to parts of the banking and insurance structure. And again, not necessarily a bad thing, but this is where having a sense of the linkages, understanding the sizes, the AUM, all of these things and the underlying quality of the assets, it's important. Generally the sunlight is a good thing in all of these.
THOMAS MUCHA:
All right, Amar, I want to thank you for the time that you spent with us here today. We covered a lot of ground. And it was all fascinating. Once again Amar Reganti, fixed income strategist here at Wellington. Thanks for being with us on WellSaid.
AMAR REGANTI:
Thanks a lot. Thanks for having me, Thomas.
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