Regional bank collapses are cutting into credit availability, doing some of the Federal Reserve’s work as the central bank looks to tighten credit, said Tony Yoseloff, chief investment officer and executive managing member at Davidson Kempner Capital Management.
(Bloomberg) — Regional bank collapses are cutting into credit availability, doing some of the Federal Reserve’s work as the central bank looks to tighten credit, said Tony Yoseloff, chief investment officer and executive managing member at Davidson Kempner Capital Management.
Davidson Kempner has about $38 billion in assets under management. Yoseloff spoke to Bloomberg’s Erin Hudson in a series of conversations ended on May 4. Comments have been edited and condensed.
Do you think there’s consensus building on where we’re at in the cycle?
There are very mixed viewpoints on what the next five and 10 years are going to bring. I think there are investors who think that we’re in a low growth inflationary cycle for a long period of time, and there are people who think that what’s happened in the last 18 months is a blip.
Our belief is that the 1970s is the right paradigm.
Read more in this week’s Credit Brief: Private Credit’s Challenge
Why is that?
There were three successive attempts by the Fed to raise rates to break inflation and it turns out that when you raise rates very rapidly, it causes a lot of damage to the economy, which hurts people.
So politically, many people don’t want rates to go up, so there’s been a tendency to declare victory on inflation too soon versus really stamping it out. Obviously there are many differences in the world in 2023 compared to the 1970s, but we see this movie playing out again and we think by definition higher rates are just going to lead to substantially lower growth.
Inflation is a psychological phenomenon. It’s not just a numeric issue. Once suppliers of goods believe that they can continue to lift prices they tend to do it. And once consumers of goods believe that they’re going to continue to pay higher prices, not only are they more accepting of it, they also plan their lives and their businesses around that.
We’ve gotten used to 2% inflation or less in the last 20 years but that just may not be realistic on a going-forward basis.
How does opportunistic credit fit into portfolios now?
There are a lot of allocators who are overallocated to venture and growth equity strategies. We wrote a whitepaper about how opportunistic credit can offer returns that are uncorrelated with those strategies. It can also offer cash flow via distributions when growth funds are unable to.
What do you expect to happen with rates this year?
I think the market believes that the Fed is going to stop raising rates and potentially start lowering rates this year. Time will tell that if that’s successful, but we view the Fed’s potential abandonment of the 2% inflation target as basically its suggesting that it’s not possible to get inflation back to where it was anytime soon.
And if you have a period of time with inflation between 3% and 5% versus 2%, number one, that’s not a victory. And number two, that can easily lead to a flareup later on, three or four years down the road versus having inflation go back to 2% or less like we’ve enjoyed for a very long period of time.
What are the impacts of the recent bank failures?
We think it’s gotten a lot more expensive and a lot harder to get capital. The regional banking system is very important to the economy of the United States and we think there’s a challenge right now where confidence in having deposits in those banks has not been fully restored and also banks have to pay more for those deposits than they did previously as a result of these banking crises.
You can see it firsthand where if you need to refinance right now, it’s more expensive to do so. There also are a lot of lenders who are looking to shrink their books because they don’t have the deposit base anymore to support the level of lending that they were doing.
I think unless there are systematic changes made to how we think about deposits and deposit insurance in this country, that’s not likely to change in the near term. So I would say the Fed is getting the credit contraction it might have been looking for in raising rates, but it’s coming because of the regional banking crisis that’s been created.
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