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Telis Demos: Hi, Miriam.
Miriam Gottfried: Hi, Telis.
Telis Demos: So, where are you today? Looks like you’re not in the usual spot.
Miriam Gottfried: I am not. I am stuck in Miami because my flight back to New York was canceled. A lot of people might say I’m lucky to have avoided the snowstorm, but it’s going to be a little bit hard to get back.
Telis Demos: Yeah, judging from outside my window, it’s pretty wintry out there. So I can’t promise you you’ll be on a flight back anytime soon.
Miriam Gottfried: Well, I’m happy that I could be here to join us anyway for this conversation.
Telis Demos: Well, it’s going to be a big conversation because this week we’ve got a few topics to cover. We’re going to talk about Wall Street deal-making, some potential changes to the mortgage market. But we’ve also got, well, we’ve got tariffs back on the brain. I know when we were doing this show a year ago, we were talking all tariffs all the time. And it feels a little bit like Groundhog Day. I don’t know, what’s the song from that movie? IEEPA Got You, Babe. I think we’re experiencing some of that in the markets today. Tariffs are certainly, once again, the topic du jour. And this week, we’re actually going to talk through all of our topics and all of the big news in the markets with our guest. Listeners to this show might remember from last year, he joined us to talk about the Fed last year. But once again, we’ve got Rob Kaplan joining us. Rob, as you might remember, he’s been at times an investment banker, a central banker, a professor. Nowadays, he’s vice chairman at Goldman Sachs. Rob, welcome to the show.
Rob Kaplan: Great to be with you guys.
Miriam Gottfried: The big news that’s been out there is, the Supreme Court striking down President Trump’s tariffs or much of President Trump’s tariffs as an illegal use of the president’s trade powers. And was that what you expected?
Rob Kaplan: We knew it was a significant probability or possibility. I think the administration was well-prepared for it also, which is why you saw them immediately or pretty close to immediately move to extend new tariffs with different authorizations. I think the market had a pretty positive reaction on Friday, and maybe they took from that that there was room to do a little bit more. So they changed it from 10 to 15% from Friday to Saturday. But this new authorization, whatever it is, Section 122 that lasts for 150 days, I think they were very well-prepared to put that in place because they thought this might happen.
Miriam Gottfried: And how do you view the way the markets reacted so far? You said that it was a pretty positive reaction on Friday. It seems like it’s not been a huge move, though.
Rob Kaplan: There’s a lot of questions left. The average tariff rate with all this said is going to be a little bit lower. It has a little bit more effect on certain geographic areas in certain countries, puts a little bit of question on certain trade negotiations. And then there’s always the question, will there be refunds? Literally, the jury’s out on that. They need to look to a lower court. And then what will the mechanic be? So, there’ll be questions. But I would guess the market will settle itself down ultimately over all these changes and get accustomed to them.
Telis Demos: I’m particularly interested in the reaction in the Treasury’s market because the tariffs had a couple of components to them, and one of them was the fiscal dimension. Tariff revenue was coming in, and that was playing a role in the Trump administration’s budget projections into the future. It was going to be in the trillions of dollars, theoretically. So, you would think that taking them away would imbalance the budget and maybe be negative for the Treasury’s market. Thus far, and obviously the market might make a different decision at some point, but thus far, Treasuries have rallied, yields have come down. Does that surprise you at all?
Rob Kaplan: The amount of money that we’re talking about at issue is about $100 billion to be potentially refunded. The old tariffs under what it was called the IEEPA have been basically almost fully replaced by the new authorizations. So the only really open question is, is this $100 billion, will it be refunded? And how might it be refunded? So, it’s not that much money that we’re talking about in the scheme of a $30 trillion economy and, let’s say, 1.75 to $2 trillion deficit.
At the same time, what the market’s also focused on is, for a range of reasons, we’re expecting very strong GDP growth in 2026. You’ve got substantial tax incentives, tax on tips, tax on overtime, accelerated depreciation. At Goldman Sachs, our economists believe that could add at least three quarters of 1% to GDP growth. The shutdown from fourth quarter, which you notice slow GDP growth in the fourth quarter, some of that is going to cause the first quarter to be a little stronger than it was. And so that’ll help growth. And then you’ve got regulatory reform, which we think will help. And lastly, as we’ve been talking about, we’re in the middle of an AI data center power infrastructure boom.
And so, it’s our expectation at Goldman Sachs, our accounts believe GDP growth will be 2.5%-plus. And then the question is, with that growth and whatever inflation is, will nominal growth be high enough to maybe bend or reduce the annual deficit from last year? That’s a possibility. And so all those factors weigh on the back end of the Treasury curve. A little higher growth would make Treasury rates a little stickier. Better, lower deficits will be helpful. And so, that’s a whole range of factors. But the net of it all is a sticky 10-year, but it’s been pretty well-behaved, I would say.
Miriam Gottfried: I want to dig into AI a little bit more. I mean, we’ve seen the market continuing to digest these big, big changes that are coming through from the AI companies, the big hyperscalers and the LLMs. And we’ve seen that particularly in sectors like software, which have sold off a lot as people fear that software will be hurt by AI. But people also don’t seem to be giving up on stocks overall. So, I mean, how would you describe the way investors are repositioning themselves right now?
Rob Kaplan: The phase we’re really in the middle of right now is the infrastructure part. Not completely, but heavily. That’s the chips, power, data centers, all in service of creating more compute. That’s very stimulus to GDP growth. The next phases that are unfolding are the adoption phases downstream. I.e., will companies, all the rest of us, companies that are users of AI and AI tools, will we adopt those tools? And how widespread will the adoption be? I think the hyperscalers are betting the adoption is going to be wide enough that we’re going to need even more compute than we’re currently creating.
The infrastructure part is stimulative. And you might even say it makes costs stickier because we need more labor, we need more materials, we need more power. But the adoption part, i.e., if businesses aggressively adopt AI, which we believe they’re going to adopt AI at least at some pretty healthy pace, that over the horizon actually is going to make businesses more efficient, is likely to improve margins. We think it could add a half a percentage point to annual GDP growth through greater productivity growth. And if we get that productivity growth, that aspect should be disinflationary. And we’re going to see that disinflation potentially unfold as we work through ’26, ’27, and ’28, as this adoption phase gets further along. And so, that’s how the market sees it.
Now, the last point you talked about, the impact on financial assets, there are going to be winners and there are going to be losers. And what the market is trying to wrestle with is, if there is widespread adoption and there are these new tools being announced every few weeks from Anthropic and other companies, are they going to disrupt some existing companies, incumbent companies? Software has been a recent example, but I think there’ll be more. And what you’re seeing is, what investors are doing are using this as an opportunity not to sell risk assets but to reposition within risk assets. The overall stock market has been, although it’s been kind of flat this year, but it’s not sold off. But you see within the stock market, there’s a bunch of sector adjustments going on depending on the industry. And I think you’re going to see more of that.
Telis Demos: Yeah, seems like investors are fleeing to what you might think of as defensive companies. There was an article in the Journal talking about HALO stocks. That stands for heavy assets, low obsolescence, a phrase coined by Josh Brown. And what that refers to are basically companies with big traditional assets, brands, names like McDonald’s, ExxonMobil, Walmart. Costco’s reporting earnings this upcoming week. Their stock is up 14% this year. Do you think that that’s about being defensive? Do you think that’s about believing that those companies will survive the AI transition, adopt those technologies and become more efficient in the future? Does that repositioning surprise you, to see more of those big, traditional Dow Jones Industrial Average-type names really being favored?
Rob Kaplan: So, it makes sense. And the market views on this will adapt and change. But yeah, first of all, we’re expecting strong GDP growth. That helps a number of these companies. And as you said, they’re likely to also be adopters where they can and become more efficient. And also, the other thing that investors are judging, maybe these companies have a good chance not to be disrupted by AI, whereas there are other types of businesses that are more likely to be disrupted or greater risk of being disrupted. So, yeah, markets are making those judgments. But the thing about markets is, those judgments get refined and then re-refined and then re-refined. And you’ll see that process continue globally and in the United States as we go through this year. Some of the fears, the market may decide ultimately were overblown about disruption. Maybe it underestimated the risk in other sectors. And so, that type of repositioning you just described, though, makes sense. And I think we’ll see more of it.
Miriam Gottfried: With all of this disruption that we’ve talked about coming from AI that’s changing the labor markets, is changing the way companies allocate capital, is that prompting companies to do more deals? A year ago, when we saw the shift in tariff policy, it basically put big deals on ice for a while. Are we going to be frozen again or is there just a lot that companies need to get done on the dealmaking front?
Rob Kaplan: We’re seeing a very high level of merger activity, and we think that’s going to continue. So, there are a few drivers. One of the drivers is, in order to adapt to AI, you need to spend more money to invest in these tools. And in the short run, it means you may have to take it out of margin. The second part is your risk, depending on what industry you’re in, your risk of being disrupted may go up. And so I think many companies that we’re talking to are feeling that they need more size and scale and depth to be able to compete in this environment and are taking the opportunity to be much more open-minded about doing merger activity.
The other comment I’d make is, in a period where disruption is higher, you’ve got to be a lot more careful about being leveraged. And so, for a lot of my business career, a big portion of it, we tended to use financial engineering as a big part of generating return, and companies did. I think we’re in a period now, because there’s more uncertainty, and AI and disruption risk are going to create more uncertainty, I think people be much more careful about having more minimal leverage, not being as highly leveraged because it reduces… You have more operating risk, you don’t want to have excessive financial risk. And that’s why we’re also seeing the larger share of this merger activity is corporate to corporate, as opposed to private equity led.
Miriam Gottfried: Well, if I’m a private equity firm in this environment, I need to use leverage, right? That’s a big key part of my business model. What are private equity firms doing, and how are they sort of de-risking in this environment with the threat from AI?
Rob Kaplan: So, they’re assessing their portfolio, and many of them have ambitious plans to monetize a number of their portfolio companies, and depending on the strategic value of each of those companies, determine how able they are to do that. But the other thing, I think you’ll see deals that are done where if you’re going to be leveraged, it’s going to have to be in very specific industries where you’re more confident there’s not as great a disruption risk. And I think otherwise, you may see firms focus more on somewhat less leverage in the capital structure in order to acknowledge the idea that you’ve got more disruption risk and they want to have a little less financial risk, given operating risk is a little bit higher. They’ll find ways to manage through it, but I think there’s some strategic work being done at these firms to rethink how they want to handle their existing portfolios, and I’m confident they will work through that.
Telis Demos: Well, that’s certainly something that I think the market’s going to be looking at very closely. The shares of a lot of the big private equity, private credit managers have kind of taken a big hit this year, as I think people are wondering about the future of that model. And then to your point about, “Will companies use leverage?” I think there’s also a lot of focus. I know we’ve been writing about this all the time, about the Big Tech companies and their use of leverage, the companies that haven’t traditionally been tapping the debt markets maybe seeing the need to do so just because the investment dollars are so enormous. I think those will be big market themes.
Rob Kaplan: Let’s separate these two. So, there’s the big hyperscalers that are, in their own right, multi-trillion dollar companies, highly profitable, and are outstanding credits, and are not used to even needing debt. And yes, a number of them are using debt to build compute, power, data center, and build out the infrastructure. The good news about those companies, they’re still outstanding credits. And I think they’re well positioned to manage this investment. And if it turns out in hindsight some of this investment is a little bit excessive, which I’m not sure we’re going to conclude that, but if that were to happen, they’ve got trillions of dollars of equity cap to cushion it.
Then you have downstream a whole range of other technology companies, whether it’s in software or other industries, where their issue is a little bit different. They’re vulnerable to being disrupted, and they’re relooking at their capital structures to make sure that they can manage through that disruption and they don’t want to be overly highly leveraged. And so that’s where you’re seeing some of the stress. And the market, as it usually does, it shoots first and it asks questions later. And so it makes judgments, and sometimes it overreacts. And then as the dust settles, it gets a clearer picture. And I’d say in the last number of weeks, you see what often happens, the market’s reacted. And I think as the dust settles, you’ll get a more nuanced view over the next several weeks and months.
Telis Demos: Well, we’re going to take a quick break. And when we come back, we’re going to shift focus a little bit. We’re going to talk about mortgages and housing with our guest, Rob Kaplan of Goldman Sachs. More on that in a moment.
So, Rob, I’m going to ask you to put on your central banker hat for a moment because I want to ask you about something interesting happening at the Federal Reserve on the bank regulation side. And that is a big look at rules around banks’ capital and how it applies to mortgages. Basically, in a nutshell, it seems like what the Federal Reserve has been talking about is making it easier for banks to make mortgages again, making it more cost-efficient for them to do so, to own the servicing rights, that means to actually collect the money. And all this is done in the service of trying to make mortgages cheaper. What do you think about that as kind of a big policy goal? What do you think about that from a central bank point of view? Where is this headed, do you think?
Rob Kaplan: So, I mean, big picture, I think there’s a regulatory review and regulatory changes going on driven by the Fed. Tough regulation is very appropriate. Tough stress testing is very appropriate. But I think the question’s being asked, in a country that’s aging, that’s highly leveraged, debt-to-GDP over 100%, we need more growth. We need more productivity growth. Doesn’t it make sense to look at cost-benefit analysis of regulation? And this is going on in a number of sectors, but in the banking sector to see that we can do more to help generate growth in the economy. And so, that’s the overall thing that’s going on.
On the mortgage front, the issue many banks have had is just the mortgage business has been quieter because there hasn’t been as much volume. And so, I think the administration and others are looking at a whole range of action. It’s more of a mosaic, a puzzle that could help improve the ability to get permitting, improve the ability of homebuilders to assemble parcels, build homes, create more affordable homes, and yes, do more to bend the curve on mortgages.
Now, a part of the answer on mortgages, if you have a somewhat lower 10-year, all things being equal, that’s going to help pull down the long end, the mortgage curve. And then you’re also seeing some actions they’re taking either to actually purchase mortgages or… and there’s also some discussions of alternative ideas for how to make either mortgages portable, which they haven’t… there’s not a solution, but it’s starting to be discussed, or other actions that might, again, get more activity that makes it easier to build a home, buy a home, and finance a home.
Telis Demos: By that, you mean the bottom line is that if we are trying to grease the wheels in the economy for further growth, then you think it’s wise to kind of think about banks and their role in lending and to basically make it a little bit easier for banks to lower some of their capital requirements and kind of unleash them a bit to sort of fuel that investment with relatively affordable lending? Is that kind of the main idea there? Do you agree with that direction?
Rob Kaplan: So, the idea starts with, are there actions that could be taken that would free up, without the banks having to raise capital, literally just free up some of the capital they already have that’s being held to the side because of current regulations? And I think what’s being revisited is, yeah, are there actions that could be taken that would allow the banks to have more capital that they could then use to lend and use in their business, which in turn would help stimulate the economy?
Miriam Gottfried: How do you think investors would react to a change in bank regulation or deregulation of banks? It seems like bank regulation is pretty popular among investors, no matter what political party you come from. People have been burned in the past by banks taking undue risk.
Rob Kaplan: Tough rules, tough stress testing, that makes sense. And I think we’ve been well served in the aftermath of the financial crisis. We’ve been well served by that. However, there may be a number of rules that don’t necessarily lead to more safety and soundness that restrict banks’ ability to do more in the economy. And I think the trick is, keep tough standards, but have more balance. And I think you can free the banks to participate more and be more constructive and do more business in the economy and still manage the risk. And I think some of… The market is already, I think, pricing in that some of that is going to happen. And you’re seeing that already. And I think by and large, the markets are pretty constructively receiving this right now. As long as it stays balanced as it is, I think the markets are receiving it in a constructive way.
Telis Demos: Well, we’re going to take a quick break. And when we come back, we’ve got one more question for Rob Kaplan. It is a Fed question, I will warn you, but this was a much more straightforward one. So more on that in just a moment.
All right, welcome back. Rob, we can’t let you get out of here without asking the usual sort of Fed question. I know we’ve got a Fed decision coming up in the not-too-distant future, but what do you think? What should the next move be? Should it be to hold, to cut? What do you think will happen? What do you think should happen?
Rob Kaplan: I think they should hold, and I think they will hold. The reason for that, the Fed funds rate right now is at 3.5-3.75. They cut three times in the fall. And the reason they did is they were concerned about weakness in the labor market. Even though inflation was running at, say, 2.75%, they decided to buy some insurance for the labor market. By cutting three more times, though, I would say they got the Fed funds rate down to what I think is in the neighborhood of nominally at neutral right now. The Fed funds rate, in my judgment, is a real rate of 0.75 to 1%, and then you add the inflation rate.
For those who say the nominal neutral rate right now is 2.75 to 3, they’re basically adding 2% to that 0.75 to 1. The problem is, we haven’t had a 2% inflation rate in four or five years. We’re about 2.75. So, the reason the Fed is struggling to go further right now is they’re right at neutral. And with inflation still at 2.75 and economic growth expected to be strong, they’re willing to cut, but they want to see more improvement in inflation or demonstrable improvement in inflation. Not forecasts. They want to actually see the improvement before they cut further. They may well see it by middle to late this year. And I think if they do, they will take more action. But for the March meeting, I think they’re very comfortable staying where they are.
Telis Demos: And if and when Kevin Warsh is the new Fed chair, do you expect policy to change dramatically? Or do you think it’ll take some time? Or maybe we won’t even see big, dramatic changes. What’s your expectation thus far?
Rob Kaplan: He’s going to argue that the Fed should be more forward-looking and that AI, which we talked about earlier, is ultimately over the horizon going to be disinflationary. Chinese manufacturing overcapacity is ultimately disinflationary. And he’ll want them to anticipate that improvement. I think he would have a hard time convincing this committee in March to do that. But by the time he gets in the seat… His first meeting won’t be till June. If you start to see some demonstrable improvement in inflation, I think he’ll have more luck convincing the group that they should take some action. But the tension will be he’d like them to anticipate that improvement. And also, some on the committee are worried about these mismatches in the labor market, and maybe you’ve got some more structural weakness they’d like to help with. But the bulk of the committee right now, I think, understands that, but will want to push back and say, “We’ll move when we see more improvements.” So, that’ll be the debate. And I think that debate and disagreement will be healthy. But that’ll be the nature of the debate you’re going to hear.
Miriam Gottfried: So, the question will be disinflation versus anticipated disinflation.
Rob Kaplan: That’s right.
Miriam Gottfried: And that’s what we should all be looking out for.
Rob Kaplan: That’s right. Fed, in the last five years, had a couple of periods where it went out on the limb and made predictions. Transitory was an example, and I think they got somewhat burned by it. And so I think they want to be more risk managers right now, not prognosticators.
Miriam Gottfried: I think that’s it. Thank you so much for joining us, Rob. It’s been great to have you.
Rob Kaplan: Great to be with both of you.
Miriam Gottfried: And that’s everything you need to know to take on your week. The show is produced by Anthony Bansie and Michael LaValle. Michael LaValle is our sound designer. He also wrote our theme music. Aisha Al-Muslim is our development producer. Chris Zinsli is our deputy editor. And Philana Patterson is the head of News Audio for The Wall Street Journal. For even more, head to WSJ.com. I’m Miriam Gottfried.
Telis Demos: And I’m Telis Demos. Until next time.