Raphael Stevens

Federal Reserve officials outlined plans for interest rate hikes and a reduction in the asset holdings on their balance sheet at their last meeting.
Minutes released Wednesday from the January session show concern about inflation and financial stability though members urged a measured approach to tightening monetary policy.
FOMC members noted that inflation was beginning to spread beyond pandemic-affected sectors and into the broader economy.

Federal Reserve officials set plans into motion at their most recent meeting to begin raising interest rates and shed the trillions of dollars in bonds on the central bank balance sheet, according to minutes released Wednesday.
Some officials at the meeting expressed concerns over financial stability, saying that loose monetary policy could be posing a substantial risk.

They indicated that interest rate hikes likely are on the way soon, and they said the unwind of the bond portfolio could be aggressive.
“Participants observed that, in light of the current high level of the Federal Reserve’s securities holdings, a significant reduction in the size of the balance sheet would likely be appropriate,” the meeting summary stated.
The policymaking Federal Open Market Committee decided after the two-day session that it would not raise interest rates yet but strongly indicated a hike is on the way as soon as March.
Despite the seemingly hawkish tone, stocks shaved losses after the release of the minutes.
“The market correctly interpreted them as dovish relative to expectations,” said Simona Mocuta, chief economist at State Street Global Advisors. “Frankly, I would call them anticlimactic.”

Markets have been on edge over the past several weeks as soaring inflation and hawkish talk from some Fed officials, in particular St. Louis Fed President James Bullard, has caused traders to price in the equivalent of seven 0.25 percentage point rate hikes this year. Market pricing eased some after the minutes release, with a 50-50 chance now of the Fed taking its benchmark rate up by 1.75 percentage points.
“There’s been so much hype recently that I think everybody was braced for a very hawkish tone in the minutes, and the minutes were more like, ‘We’ll do it, of course, but we’ll walk before we run,'” Mocuta said. “It seems enough for the Fed to do four hikes. Talk the hawkish talk, tell everybody that we are watching this closely, and if we need to do more we can do more.”

In addition to the rates talk, the committee set out procedures for how it will start unwinding its nearly $9 trillion balance sheet, which consists largely of bonds it has purchased in an effort to drive down rates and stimulate growth.
March is also the month when the asset purchase program is set to end, though some members at the meeting were hoping for a faster conclusion. Instead, the committee set forth a path in which the Fed will buy $20 billion in Treasurys over the next month and nearly $30 billion in mortgage-backed securities.
“A couple of participants stated that they favored ending the Committee’s net asset purchases sooner to send an even stronger signal that the Committee was committed to bringing down inflation,” the minutes said.

Stock picks and investing trends from CNBC Pro:

Members discussed how the balance sheet reduction will occur. The most likely path is by allowing some proceeds from maturing bonds to roll off each month rather than being reinvested. However, some officials said it may be necessary to sell mortgages outright in an effort to get the balance sheet holding to purely Treasurys.
Since the meeting, fresh inflation readings have shown prices rising at the fastest pace in 40 years. The Fed targets inflation to average around 2%, and officials have conceded that policy needs to get tighter to bring prices down.
Inflation occupied a good deal of the discussion during the meeting, according to the minutes. The term is mentioned 73 times in the summary, with members saying that price increases have been stronger and more persistent than they had anticipated.
“Participants remarked that recent inflation readings had continued to significantly exceed the Committee’s longer-run goal and elevated inflation was persisting longer than they had anticipated, reflecting supply and demand imbalances related to the pandemic and the reopening of the economy,” the document stated.
FOMC members noted that inflation was beginning to spread beyond Covid pandemic-affected sectors and into the broader economy.
“Participants acknowledged that elevated inflation was a burden on U.S. households, particularly those who were least able to pay higher prices for essential goods and services,” the minutes said.
There also was discussion about financial stability. Officials noted that risks are coming from elevated asset prices as well as the rapid price increases in crypto assets.

WATCH LIVEWATCH IN THE APP More

In this photo illustration the logo of Canadian e-commerce company Shopify Inc. is displayed on a smartphone.
Thomas Trutschel | Getty Images

Check out the companies making headlines in midday trading.
Roblox — Shares of the metaverse-focused gaming company plunged more than 25% after Roblox’s latest quarterly report missed Wall Street expectations. Roblox posted a loss of 25 cents per share on revenue of $770 million. Analysts surveyed by Refinitiv expected a loss of 13 cents per share on revenue of $772 million.

Shopify — The e-commerce platform tanked more than 18% in midday trading after the company said revenue growth for 2022 would be slower than the 57% it achieved in 2021. Shopify, however, beat on the top and bottom lines of its quarterly results.
Upstart — Shares of the consumer lending platform surged more than 35% after it reported earnings well above Wall Street estimates. Upstart reported earnings of 89 cents per share, topping estimates of 51 cents, according to Refinitiv. Revenue also beat forecasts. The company also issued strong first-quarter and full-year revenue guidance.
ViacomCBS – The media stock dropped 21% on Wednesday after the company, now known as Paramount Global, reported weaker-than-expected earnings for the fourth quarter. Bank of America also downgraded the stock to neutral, saying that Paramount’s focus on streaming lowered the chances of a takeover offer in the near term.
Macy’s — Shares of the department store rallied more than 4% after Evercore ISI upgraded Macy’s to outperform from in-line, saying in a note to clients that the retailer’s stock did not reflect the upside potential for its sales and profits.
Vacasa — The vacation-rental company’s stock rose more than 11% in midday trading after JPMorgan initiated coverage with an overweight rating, saying in a note that the company has some competitive edges over more established names in the space.

Airbnb — Shares of the vacation rental company jumped 5% after Airbnb reported better-than-expected results for earnings and sales in the fourth quarter. The company said the lead times for bookings in the U.S. and Europe have returned to prepandemic levels.
Generac — The stock allied more than 10% after earnings beating top and bottom line estimates for its quarterly results. The maker of generators and power equipment earned an adjusted $2.51 per share, 11 cents above estimates, as both commercial and residential sales rose more than 40%.
Kraft Heinz — Shares of the food company rose 3.5% after it reported better-than-expected earnings and revenue for the fourth quarter. Kraft Heinz report an adjusted quarterly profit of 79 cents per share, beating estimates by 16 cents. 
La-Z-Boy — The furniture company’s stock plunged more than 17% following a big earnings miss. La-Z-Boy reported earnings of 65 cents per share last quarter, well below the 89-cent consensus estimate, according to Refinitiv. The company said it experienced multiple production issues related to the pandemic.
— with reporting from CNBC’s Yun Li, Jesse Pound and Hannah Miao.

WATCH LIVEWATCH IN THE APP More

Advice and the Advisor

The U.S. Securities and Exchange Commission and U.S. Department of Labor have taken recent regulatory steps aimed at private equity and other alternative investments.
The moves would raise transparency for investors and likely reduce the pool of 401(k) plan savers with private-equity exposure.

SEC chairman Gary Gensler testifies before a Senate Banking, Housing, and Urban Affairs Committee hearing on Sept. 14, 2021 in Washington.
Evelyn Hockstein-Pool/Getty Images

The Biden administration is lending a more cautious eye to private equity and other “alternative” investments such as hedge funds.
The U.S. Securities and Exchange Commission and U.S. Department of Labor have taken steps in recent weeks to boost transparency for investors and rein in the pool of retirement savers who can buy private equity.

Private equity refers to investment in an entity that isn’t publicly traded (unlike stock in companies such as Apple and Microsoft, which is available on a public exchange).

More from Advice and the Advisor:

The investment category is generally off-limits to anyone who isn’t an “accredited” investor, someone deemed to have a minimum level of income, wealth or expertise to participate. (Retirement plans pose a slightly different dynamic; in this context, the employer acts as a gatekeeper that can choose to make private equity available to its workers.)

“The Biden administration, through various agencies, is taking a deliberate look at the potential impacts of the private equity market, especially on retail and retirement investors,” said Dylan Bruce, financial services counsel for the Consumer Federation of America, an advocacy group.

What regulators are doing

The SEC on Feb. 9 proposed a multipronged rule to increase transparency, by requiring private-equity funds to issue quarterly statements detailing fees and performance, among other things.
It would also limit the preferential treatment some investors get, such as additional disclosures that may have a “material negative effect” on other investors, according to the SEC. It would also require an annual audit of private funds and prohibit funds from engaging in certain conflicts of interest.

Separately, the Labor Department published a notice on Dec. 21 designed to limit the scope of Trump administration guidance from June 2020.
The Trump-era labor agency laid out legal parameters for employers to consider if they’d like to offer employees a 401(k) plan fund with an allocation to private equity. But the Biden administration limited the memo’s application, though didn’t repeal it.

These well-heeled, well-represented investors are able to fend for themselves, and our resources are better spent on retail investor protection.

Hester Peirce
SEC commissioner

Specifically, the agency said employers already managing private equity for the company pension plan are likely best suited to analyze whether private equity makes sense for their 401(k); the department “cautions” other companies (i.e., those not fluent in private equity) from doing so.
“They put more ‘guardrails’ about what the June 2020 letter said,” Julie Stapel, a partner at law firm Morgan Lewis, said. “It’s not an endorsement or acceptance of widespread use of private equity … without that prior expertise and experience.”

More investors

The additional regulatory focus is largely because the market and access to private funds (like private equity, venture capital and hedge funds) have grown in the past few decades.
The funds hold $18 trillion in gross assets, according to SEC Chair Gary Gensler. Globally, private equity assets have grown tenfold since 2000, about three times the pace of public stocks over the same period, according to McKinsey, a consulting firm.
Further, 16 million households were eligible to buy private funds in 2019, up from 1.3 million in 1983, according to SEC data.
That amounts to 13% of all U.S. households in 2019, versus 1.6% in the early 1980s. The share likely increased after 2020, when the Trump administration expanded the pool of accredited investors.

“Sometimes, [the investors] are wealthy individuals,” said Gensler, who was appointed by President Joe Biden. “Often, though, they’re retirement plans, like state government pension plans, or nonprofit and university endowments.
“The people behind those funds and endowments often are teachers, firefighters, municipal workers, students and professors,” he added.
Consumer advocates worry about increased access. Private investments carry more risk and opacity and have less liquidity if an investor needs their money, they said.

Performance

But proponents tout the higher return potential of private equity relative to the public stock market.
Private equity yielded a 15.7% net annual rate of return, at the median, over the past decade, relative to 14.8% for the S&P 500 Index, according to an analysis by the American Investment Council, a trade group representing the private equity industry.
“The [regulatory] guidance reaffirms that private equity is a valuable investment option and an important part of a diversified portfolio,” said Emily Schillinger, a spokesperson for the American Investment Council, a trade group. “A wide range of data confirms that private equity delivers the strongest returns to public servants and retirees across America.”
The performance gap between private equity and public stocks has “narrowed,” according to a report by Michael Cembalest, chairperson of market and investment strategy at J.P. Morgan Asset Management.

In 2009, the average private-equity fund outperformed the S&P 500 by 15%. However, that outperformance has since fallen to 1% to 5% a year — which investors may not think justifies its illiquidity relative to public markets, Cembalest said.
Regulators deem accredited investors to have the knowledge and wealth to bear the financial risk of alternative investments.
Households must have a net worth of more than $1 million (excluding the value of a primary residence) to qualify. Individuals may instead qualify with annual income of more than $200,000 during the last two years (or $300,000 for married couples).
Those thresholds aren’t pegged to inflation, which is a primary reason the ranks of accredited investors have grown since the 1980s.
Not all SEC officials think more regulation for private equity is a good idea, though.
“These well-heeled, well-represented investors are able to fend for themselves, and our resources are better spent on retail investor protection,” SEC commissioner Hester Peirce, who was appointed by former President Donald Trump, said Feb. 9. “Accordingly, I am voting no on today’s proposal.” More

(Click here to subscribe to the new Delivering Alpha newsletter.)
Lawrence Golub helms one of the largest private credit shops in the alternative finance space. His eponymous firm, Golub Capital, has $45 billion in assets under management. That’s no small feat against a backdrop where private debt AUM is expected to total $2.7 trillion by 2026. 

While private debt has skyrocketed recently, inflation and rising interest rates could pose new challenges. Golub sat down with CNBC’s Delivering Alpha newsletter to discuss how these headwinds impact his firm’s lending strategy and where he thinks the Fed went wrong in taming inflation. 
(The below has been edited for length and clarity. See above for full video.)
Leslie Picker: Private credit is floating rates so it still may be an attractive asset to investors in a rising interest rate environment. But how does the broader macro backdrop change the way you dole out capital?
Lawrence Golub: We’re looking for resiliency in the borrower against things that could go wrong. So when you have interest rates rising, it does reduce the margin of safety somewhat, when you’re looking at the ability of the company to service its debt. That has to be taken in the broader context of what’s going on with the economy as a whole and the economy really is doing very, very well. The inflation is driven by strength, not weakness. And in this environment, our portfolio has been performing at among the best levels ever, in terms of very low default rates. And it’s been a very robust, healthy environment.
Picker: What’s interesting is that your lending covers a swath of the economy that we don’t always see – it’s private companies, middle market, increasingly larger companies. What can you tell us about their resiliency, especially in the face of inflation? Is that starting to creep into their margins?

Golub: We pride ourselves on being extremely careful in who we pick to be our partners. Absolutely inflation is feeding into the performance of companies. We segment the various industries that we lend to and we have a quarterly report. And in the industrial sector, even though there’s been robust demand, that’s one area where profits haven’t been as strong because companies, due to supply chain issues, have had trouble meeting all of their customer demands. Nonetheless, in the middle market, profits are up almost 20% year over year so it’s been very robust. 
Picker: Do you feel like the Fed is ahead of the curve here, that they are on top of the inflation picture and will be able to adequately bring it down from these levels?
Golub: The Fed will eventually be able to bring it down if it has the will but the Fed is way, way, way behind the curve. When inflation was 1.7% versus their target 2%, the Fed expressed great concern, “Oh, my, we’re not at our targeted levels. We’re not going to raise rates until we actually see the data with inflation over 2%.” Now that inflation is over 7%, the Fed is going slow. It’s not taking the action that it said it was going to take. I think this is a mistake. Larry Summers, on Friday, said the Fed should call an extraordinary meeting and immediately end quantitative easing. I think he’s right. 
When you look at factors like the quit rate and the open job rates, we have an economy that’s closer by historical standards to what you’d normally see as an unemployment rate of 2% or 3%, rather than what’s being measured. So we have a lot of unmeasured inflation. We have housing costs that aren’t properly reflected in the CPI. We still have a few more months coming up, where the month-over-month comparisons with last year are going to be beaten and the headline inflation rate is going to go up some more. So the Fed is going to tighten, they are going to tighten a lot. I don’t think anybody really knows when the Fed is going to start letting its balance sheet taper off some but they will need to take action and it remains to be seen how soft a landing they’ll be able to engineer. 
Picker: What’s the chance that they get it wrong and we ultimately wind up in some sort of a recession?
Golub: There’s a decent chance of that. The question is more of a when, then than anything else. We’re seeing in our results from companies and in backlogs tremendous strength, we don’t see much of any chance of a recession this year. And that momentum will probably carry on well through next year. One of the side effects, though, of the supply chain issues is that businesses of all different types are raising their targeted inventory levels. So as they add to inventory when they eventually start being able to catch up on receiving shipments above sales, at some point, there’s the risk that they overshoot. We in the United States haven’t seen a classic inventory recession in probably 30 years. I think there’s a good chance that there will eventually be an inventory recession sometime in the next five years.
Picker: What does an inventory recession look like compared to, say, a financial crisis-driven recession?
Golub: Much milder. An inventory recession is really cutbacks in orders that run a little bit more severely than weakness in and retail sales. And historically, inventory driven recessions have been adjustments of just a few months. They’re still painful when you’re in them, but not as much to worry about.
Picker: I want to ask you about the industry that you’re in, sometimes known as private credit. Direct lending is a pocket of private credit, probably the largest pocket. You had a record year in 2021 – $36 billion worth of commitments. There have been others that have jumped into this space as well, attracted by the prospect of those investors that like an alternative to fixed income creating those similar returns for them. What’s the competition picture look like right now in this space as its prevalence has just grown to help finance the LBO boom that we’ve seen recently.
Golub: Well, private credit is bigger than it’s ever been and growing quickly. There have been new entrants and those of us who have been in the industry for years have been growing. The private equity ecosystem is probably about $2 trillion large and within private credit, or I should say private credit is gaining market share at the expense of public credit, broadly syndicated loans. As we and others have grown in the private credit space, we’re able to offer bigger solutions for a larger range of deals from private equity firms. And there’ve been at least two ways in which our industry is gaining market share. We’re gaining market share by replacing broadly syndicated lending in traditional first lien debt. And there’s been a tremendous growth in one stop loans which is very favorable for investors and also favorable for the private equity firms.
Picker: Do you believe that with the growth in private credit, that it’s created too much leverage in the system? I ask because there was that recent Moody’s report that warned that this leverage embedded in private credit’s, quote, “less-regulated gray zone” carries systemic risks. Do you believe those concerns are valid?
Golub: First of all, I don’t see any systemic risk. Private credit isn’t interlaced with the financial system, the banking system, the way other kinds of credit are. So even if we’re stupid enough to make some pretty big mistakes, there’s really no plausible way that spills over into being systematic risk. Secondly, private lenders are much smarter about the fundamental recovery, the fundamental value of the loans we make. You can go back decades and our credit losses, we the industry, Golub Capital’s, does better, has lower credit losses than our industry. But even the industry as a whole has lower credit losses than banks ever did in their private equity lending at lower leverage rates. And it has to do with the alignment of interest, long term focus, a real orientation on lending against value as opposed to just some regulator driven credit metrics. 
And having said that, leverage levels have crept up just as enterprise values have crept up. The stock market, private equity industry, multiples are very, very high and there’s no change in sight. We’re not seeing any reduction in those multiples. So you have this balance between high growth rates and profits, increases in value businesses, the fact that private equity firms do a really good job in general at running the companies that they’re lending to, the fact that private lenders do a very careful job and we have our money where our mouths are, balanced against what’s the right long term amount of leverage. We at Golub Capital are focused on lending for resiliency and not lending for perfection. But it’s absolutely something investors should think hard about, particularly when they’re picking an investment manager.
Picker: What’s the difference between resiliency and perfection?
Golub: Resiliency is what you need because you can’t have perfection. If you’re lending against a financial model, and you’re pushing the amount of leverage to the limit of how much is LIBOR or SOFR going to go up, and you’re not taking into account the possibility of a recession, you’re pricing to perfection or structuring to perfection as opposed to structuring for resiliency…When we’re underwriting a loan, we’re not looking at credit ratios. We’re looking at what we think that distressed sale value of a business will be if a bunch of things go wrong. And if we’re lending within that expected distress sale value, that’s resiliency, ultimately, because it gives everybody room to come up with solutions. More