Sonali Basak, chief investment strategist at iCapital, joins 'Squawk on the Street' to discuss a possible December interest rate cut, private credit, and more.

Washington

Sonali Basikas, Chief Investment Strategist at iCapital, discussed the Federal Reserve's potential for a rate cut in December, citing a rising unemployment rate nearing 4.5% and stable core PCE projections. She noted that while a December cut would be the third in a series of risk management moves, further cuts next year are uncertain without a more dovish Fed stance.

The conversation also addressed risks in private credit markets, particularly from deals made in 2021-2022 and concerns about liquidity and defaults. Despite these risks, default rates remain at historical averages, and aggregate credit quality has held up, though ongoing questions about marks and liquidity are expected to persist.

Rising unemployment rate suggests Fed will cut rates in December

Joining us to talk more about the AI trade in the markets and the Fed, Sonali Basikas here, Chief Investment Strategist at iCapital. Congratulations on the gig, by the way. Thank you so much. It's great to have you. Maybe we could start with the Fed, because we were just having a conversation about Fed odds, the Nick Timoros piece in the journal today, maybe carving a path to at least a hawkish cut in December. Does that make sense to you guys? It did, because if you think about the case for cutting in December, not a lot has actually changed. We've seen expectations from the summary of economic projections, and the expectation was core PCE to be around 3.1 percent this year, but the unemployment rate is edging towards that 4.5 percent level. So that would suggest, yes, a third in the series of risk management cuts. Now, where we're less convinced is into next year. Whether you start to see more cuts heading into next year until you see a more dovish Fed, what does 25 basis points actually do? We have certainly seen the S&P 500 react more firmly to the prospect of another rate cut. But beyond that, how much more juice do you get is starting to be a very relevant question. So at iCapital, you guys are really focused on the private markets, right? And we're starting to scrutinize more what's happening in places like private credit. What are you guys, what are you seeing, and how correlated is it with public markets at this point? One thing that's really important to notice here is a vintage risk. The deals that were cut during 2021 and 2022, where valuations were not that good, where the rate environment changed drastically coming out of that, we think that's going to be a very topical question going into next year, because private credit and credit largely is not a riskless proposition. That doesn't mean there won't be losses. We just think that the whole conversation over the last couple of weeks has certainly been lumped together. Is this a question of losses and defaults on the books? Is this a question of liquidity, which is a really relevant question in this market? A lot of people got into these structures thinking they were liquid, and they were not, right? And in fact, they weren't even marketed as such. So we think that these are really good questions heading into next year. Certainly at the margins, you're going to see some defaults, but a lot of the market is not necessarily tied to that K-shaped economy. That's where we think you're going to see most of the pain, where you're more weighted to the lower-income consumer, perhaps, certain forms of consumer credit. If you look at the most recent data, even the PPI today, for example, insurance costs in auto and home, still high. And that's something worth looking out for as we look at where we're going to look for credit quality deterioration. Yeah. I do wonder. I mean, you know, there have been questions, obviously, about underwriting standards. Marks are always a key concern. At the same time, I mean, Apollo did a big presentation yesterday talking about Athene and how matched they are and rebutting a lot of really those concerns that have seemingly come in in the last, let's call it, couple of months in private credit markets. Yeah, as you guys have seen, the default rates have remained historical averages, but relatively low, between 2% and 3.5%, depending on where you look. Another thing that's happening in the market that's important is more frequent marks. Monthly marks are a welcome point in this market now. And where you'll see diversion in those marks among different managers, the aggregate credit quality has held up. I think it's those other questions around marks and liquidity that are going to be the bigger question and worth understanding.

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