The Federal Fund Rate will shift to a new range of two to four percent, up from its previous range of zero to two percent over the next 10 years, said Howard Marks, Co-Chairman of Oaktree Capital Management, in an interview to Bloomberg TV.
Sharing his perspectives on the current financial landscape, he presented a compelling outlook for the next decade. He shared his views on the side-lines of the HKMA Global Financial Leaders' Investment Summit and touched upon a range of topics. The Federal Funds Rate is a key metric that influences various financial aspects.
Queried on whether we have reached the peak interest rates, Marks offered a nuanced response: "I don't know, how low do we get in the next cycle?" This brisk acknowledgment of uncertainty defines today's economic climate to a large extent as the world is currently enduring two wars, the Russia-Ukraine war and the Israel Hamas war, both of which can have long-term ramifications on global geopolitics.
Marks' views on interest rates remained cautious but pragmatic. He said, "The one thing I'm confident about is that I don't know. But I think that rates may go a little higher, but not terribly much higher from here. There's substantial progress being made against inflation, and that's what matters."
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Intriguingly, Marks pointed out that the next decade is likely to bring about significant changes compared to the past. He remarked, "The thesis explained in his recent memo 'Sea Change' is turning out to be true and that the next 10 years will be very different from the last.”
He further underlined the importance of this perspective stating, "What do I do with this information? What investors must do is to understand the importance of adaptability in the ever-evolving world of finance and position themselves accordingly.”
Historic backdrop of declining interest rates may be changing:
When it comes to investments, Marks suggested that the historic backdrop of declining interest rates may be changing. "If you came into this business since 1980, which covers almost everybody, you've only seen either declining interest rates or ultra-low interest rates. You have to go back into the seventies to have seen a different climate, which I fortunately did do." These historical observations led Marks to conclude that the long-term trend of falling interest rates may be coming to an end.
Marks' assessment continued with insights into the actions of the Federal Reserve. "Number one, there's not much room for a further decline. And number two, I think the Fed probably understands that it kept rates too low for too long and that there was a negative consequence, certainly in terms of inflation." This perspective highlights the delicate balance between stimulating economic growth and maintaining price stability.
In his published memo, "Sea Change," from December, Marks also revealed his reservations about making precise predictions. He admitted, "I don't believe in forecasts, especially my own," but he broke with this tradition to offer a directional outlook, stating, "For the next decade, the Fed funds rate is more likely to be between two and four than between zero and two." This projection signals a shift from the ultra-low rates of the past and towards a period of potentially moderate interest rates.
Further, on the potential implications for investors due to the change in interest rate cycle, Marks raised questions about the suitability of equity markets in such an environment. "Do I have any business then, being in the equity market?" he pondered. While highlighting the past performance of equities with the reminder that "S&P has given a 10.2 percent return every year on average for the last century," he offered an alternative view.
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Marks proposed the idea that credit investments could be a compelling option. "Right now, it looks like you can get equity-type returns from credit. A little below 10 percent for what we call liquid credit stuff that's tradable every day and well above 10 percent, perhaps for private credit, which is not tradable."
The potential benefits of credit investments, which include the ability to surprise on the upside, were contrasted with the obligations they carry in the capital structure. Marks pondered, "So my question there would be, you know, for longer-term investors, let's say, they have to match their liabilities for 30 years, insurance companies come to mind as well. Is the proposition fixed income and not equity markets because equities tend to give you longer-term returns more consistently?"
What happens with credit investments in a recession?
Marks' in-depth conversation also explored the relative risks of credit investments, especially in the event of a recession. With the novelty of the private credit asset class, the untested waters of a real recession prompted the question, "What happens if we face a recession?" This was complemented by his observation: "I can't think of a recession since this whole process began." The uncharted territory of private credit amid economic downturns warrants careful consideration.
Hence, Howard Marks's insights in the conversation sheds light on the ongoing uncertainty surrounding the equity markets currently and the expectation of the federal funds rate fluctuating between two percent and four percent over the next decade, he even suggested that investors must remain adaptable and consider diversified strategies to thrive in a rapidly evolving financial world of today.
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