Spinal Tapping into interest rates

Ryan Caldwell, CIO of Chiron funds, explains why “up to 11” is the perfect metaphor for how interest rate policy is affecting portfolio construction. Plus, a roundtable discussion of recent economic events and what they could mean for investors.

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November 13, 2020 | 6 minute read

About this episode

In this episode, Ryan Caldwell, CIO of Chiron funds, is joined by FS Investments Chief U.S. Economist Lara Rhame, FS Investments President Mike Kelly, Chiron Head of Trading Peter Bianco, and Chiron Portfolio Managers Brian Cho and Scott Sullivan. Ryan opens the show by explaining how ’80s mockumentary Spinal Tap is the perfect metaphor for how interest rate policy is affecting all things portfolio construction, and the group gives their take on recent economic events and what they may mean.

Transcript excerpt

Ryan Caldwell (00:00:18):

This is Ryan Caldwell. I am the CIO at Chiron investments. And today I am joined by a few colleagues and we are going to relaunch the Chiron podcast, it’s been a little bit. For those of you that are not aware, we, being Chiron, were acquired by FS Investments in Philadelphia. We have been diligently working through our integration process and obviously focusing on markets and strategies. And we thought that this would be an opportune time to rekick off the podcast in a very fresh way. And so I’m excited today to be joined by a couple of new guests on the podcast. Today, we have Lara Rhame, the chief economist at FS Investments, as well as Peter Bianco, who is the head of trading at Chiron. So Lara, Peter, welcome to the podcast.

Peter Bianco (00:01:15):
Good to be here.

Lara Rhame (00:01:17):
Thank you.

Ryan Caldwell (00:01:19):
We are also joined today by a couple of people, our listeners I’m sure are familiar with, Brian Cho, who runs our quantitative group, and Scott Sullivan, who helps me with the fundamental implementation of the fund. So Brian, Scott, welcome back.

Brian Cho (00:01:34):

Good to be here.

Scott Sullivan (00:01:39):

Good to be back.

Ryan Caldwell (00:01:40):

I thought what I would do is maybe do a little bit of explaining, given the intro. For some of our listeners and readers who are familiar with us, we generally do music as an intro. Every now and then we do movie clips. And what I wanted to do was maybe frame this one a little bit and give a little bit of the backstory. And so for our third quarter 3D report, and our readers and listeners will be getting this here momentarily, opened up that piece with a clip and some dialogue from the movie Spinal Tap. And so for some of you younger listeners who may be weren’t around for mid ’80s mockumentaries, Spinal Tap is a classic, Asher’s Rob Reiner’s first film, is a classic spoof on ’80s rock bands. And as the intro alluded to, there’s this really hysterical exchange between the band and Rob Reiner over this concept of their amplifiers going to 11, versus most amplifiers that go to 10.

Ryan Caldwell (00:02:46):

And so to pull this all together, Lara, our chief economist, and I, as well as Mike Kelly, who’s the CIO at FS Investments, we were having a dialogue post the last major Fed meeting, I guess you would say, where chairman Powell reintroduced or introduced the findings of the Fed review of their framework, which started an email chain that had a lot of banter in it, which ended up with this reference to Spinal Tap and the ability of the amps to go to 11. So I thought it was more than appropriate to maybe kick off, because again, some of our listeners may remember or have read from us, one of the things that we’ve been spending a lot of time talking about is the effect of policy, but maybe more importantly, interest rates on all things portfolio construction.

Ryan Caldwell (00:03:43):

Again, we’ve gone over this a little bit, but again, we haven’t really talked since the COVID collapse, I guess you would, in the term structure of interest rates, which again has, I would argue, supercharged everything that had gone on before. So these trends were in place and then the collapse and the risk-free rate globally, but I think the U.S. being the most important place really put a supercharger to this and everybody’s portfolio. And so here we are in October ahead of an election, we’ve had this re-introduction of a framework from the Federal reserve. And again, it’s all centered around the same thing. And I want to get into that a little bit, because we do think that, look, the really big thing is rates and inflation and given where portfolios are lined up, any outcome that maybe is outside of the markets current probability table is going to have a really dramatic effect on your portfolio and how you implement portfolio. So that’s where I wanted to spend most of our time today.

Ryan Caldwell (00:04:44):

And so Lara, Pete, I want to kick off with you two, because I want to remove this for maybe the portfolio manager lens. And I want to zoom back up maybe to 30,000 feet. And I was wondering, Lara, if you could give us a little bit of framework and staging of this whole notion of why the Fed needed to review their framework, what they concluded and maybe what they think it means. And then maybe some narrative from you on maybe what you think it means. And then Pete, I’m going to flip over to you to a trader market view of what the market thinks at heart. But I wanted to start with you, Lara, to maybe set the table because quite honestly, you’re the really only one credible to do that here. So why don’t we kick off with you, Lara, a little bit about how we got here and what is this?

Lara Rhame (00:05:37):

Thank you. Thanks very much. It’s actually typical, leave it to a government agency to make something really simple so complicated. The simple problem that the Fed has is that they’ve been trying to target inflation at 2%. And that target, it was hard to hit in the ’80s, they created this because we had bad inflation. They fought several waves of higher inflation in the ’90s, a little bit in the 2000s, considered them… Got a little overconfident thinking that they had this inflation dynamic well understood, pinned down and controlled. And then they were completely surprised by the last 10 years when actually inflation has undershot their target. Inflation averaged 1 1/2% over the past 10 years. And that has had several waves of impact throughout the market. One of them has been continued falling rates across the yield curve. The other one has been this slow grinding down of inflation expectations.

Lara Rhame (00:06:59):

So you look at the five-year OIS numbers, they have tracked around 1.7 this entire time. So long, long-term markets, not only don’t think the Fed is going to make their 2% target. This has really big implications for Fed credibility. A very real world example that we all see is the rate hike cycle that started in 2006 and really gained traction, some gained momentum in 2017, ended in 2018 with a strong about faith under the new framework where we’re now averaging inflation.

Lara Rhame (00:07:42):

I think we can very clearly draw that back to your Spinal Tap reference because the reality hasn’t changed. The Fed, you call the top of the amplifier 10, you call it 11, the reality is the sound is at seven. That’s the problem and they can’t turn the dial. So that’s really where that analogy hits home. And right now, long-term expectations are not only that interest rates are going to stay low, but that the Fed’s credibility on waging this war against inflation has actually eroded to the downside where their tools are quickly losing effectiveness.

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Ryan Caldwell

Managing Director, FS Investments

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