Central bank lookahead

0:06Pushkin. For the better part of two years, as central banks have been raising rates, it's been all about getting inflation back down. But now, across the developed world, we're entering a new phase of the central bank fight. Inflation has come down in England, Europe, in the US, and central banks have to start to think about how they're going to deal with crunch time. This is Unhedge, the markets and finance show from the Financial Times and Pushkin. I'm reporter Ethan Wu, here in the New York studio, joined as ever on Tuesdays by markets editor Katie Martin. Hey, Ethan, are you pumped for Fed Day?

0:45Are you excited? I'm so pumped. You know, every Fed Day, I roll into the office at a cool 1.30 p.m. because the press conference doesn't start till 2.30, statement doesn't come out till 2. I take the morning, I relax, and then it's an insane crunch for the rest of the day. It's absolutely so stressful, but always a good time. Happy Fed Day to all, all who observe. Always a good week to watch, Central Banks. This week is especially interesting. We had a great splash in the FT a couple of days ago titled Central Banks Prepare to Rebuff Investors Over the Path of Interest Rates, sort of spelling out the fact that markets see interest rates falling next year.

1:22Central banks aren't quite there yet. But I think the piece highlighted a really important dynamic that we should talk about both as the Fed, ECB, and BOE meet this week. And as we go into 2024, it's a new game for central banks. They have to start thinking seriously about whether interest rates fall, how fast they they fall, what should trigger them to fall. That's now a live discussion very much in the market and also, I think, increasingly among central bankers and economists too. Yeah, this is a very delicate juncture for big central banks. And as you say, we've got the big three, the Fed, the ECB, the Bank of England, all coming up this week.

1:59Bank of Japan just before Christmas. Always watch out for the Bank of Japan. But anyway, that's a whole other story. We've got the big three this week. And yeah, the market is doing some weird stuff, right? So the market is effectively saying, hooray for the Fed, they've somehow engineered this situation where they've raised interest rates really, really aggressively, and they haven't like nuked the economy. So they're saying soft landing, everything is good. But at the same time, if you look at where rate expectations are, it looks like the market is expecting quite a lot of rate cuts from the Fed, like 100 basis points or so, that's a percentage point in real money.

2:39over the course of next year, that's a lot, you know, by sort of historical standards. So these things can't be right, because normally it would only be cutting interest rates if the brown stuff had hit the fan, whereas the market is saying everything is fine, and they're still going to cut rates. So the Fed now has to, well, it doesn't have to, but the pressure is to give some guidance to investors about what is going to happen next. And the danger is that if central bankers say, look, have at it, we're going to start cutting rates before you know it. They wouldn't say that in so many words, but that sort of thing.

3:12Then the markets will go gaga, bond yields will fall really fast, stocks will rise really fast. And then guess what? You've got the inflation problem back that you thought you'd defeated. So really delicate time here. Absolutely. Markets are forward looking. It's kind of a cliche to say, but it's really important in this context, because even without central banks really saying tons about how or whether interest rates will fall next year, you're already seeing markets price it in. Like you're saying, Katie, just looking really at the economic data and not at what central banks are saying. So then you can imagine if they actually actively started talking about interest rates cuts, you know, markets would absolutely lose their heads.

3:51Yeah. The thing is, if you're expecting to dial in to watch the Fed press conference, because you have a really fun life like that, then what you're not going to get is any, is Jay Powell saying, no, sure, we're going to start cutting rates in March or, and you're not even going to find any journalists asking him any questions that are that specific. So this whole space is about tiny little hints, tiny little, not exactly a wink and a nod, but kind of very, very close to it. So central bankers have these like mad Jedi mind tricks, where they kind of get across their message without saying it super explicitly so that there's kind of plausible deniability about them having said, oh, yeah, we're going to do this thing on this day.

4:39They just try and guide the market in their kind of preferred direction. So what we saw, as you say, not so long ago, Jay Powell said something about it being a little bit premature to start cutting rates. But bear in mind, back in October, he gave a much more forceful, again, slightly kind of gnomic, but nonetheless forceful message, which was, whoa there. So he said, financial conditions have tightened significantly in recent months, and longer term bond yields have been a factor in this tightening. Now, to the trained ear, that is a very clear message that, guys, bond yields are too high. I don't want them up here.

5:16This is like tightening lending faster than we want. So we want bond yields to be lower. So that was one of the big triggers that led to the reversal in bond yields just sort of in the autumn of this year. What we have not seen is a pushback of a similar magnitude against the decline in yields that we've had since. Right. So that is the Fed's way of saying, this is fine. This is fine. You know, we're not going to tell you that you're wrong in starting to price in these rate cuts. And so certainly this week's big press conference is a big opportunity for Jay Powell to say, you lot have got this wrong.

5:56We're not going to cut as fast as you think we're going to cut. Or to say, no, carry on as you were. You can keep, you know, just keep at it. One complication for Powell in his meeting on Wednesday is that not everyone's, you know, reading his exact same script. In late November, one Fed governor, so people will know that the Fed is not just one man. It's not just Jay Powell. It's actually an entire board of monetary policy officials. And one of these officials, Fed Governor Chris Waller, said the following in late November. If we see disinflation continuing for several more months, I don't know how long that might be, three months, four months, five months, you could then start lowering the policy rate just because inflation is lower.

6:38It has nothing to do with trying to save the economy. There is no reason to say we will keep its interest rates really high. And what Waller is saying there is that if you get a sufficient amount of good inflation news, which we're not there yet, but we're not terribly far from it. If you get enough good inflation news, then that would unlock the ability to normalize policy rates, to bring down interest rates just a little bit to keep the broader approach of monetary policy consistent because the restrictiveness of monetary policy, the amount that it slows the economy is set by the real interest rate, which is you can think of it kind of like the policy rate that the Fed sets minus whatever the inflation rate is.

7:19What that means is as the inflation rate falls, you're actually kind of automatically tightening policy unless you lower the nominal rate, the headline rate, the policy rate alongside side it. So that's kind of one complexity is that you have that officials out there talking about rationales for rate cuts. That's not what you'd hear if you had kind of a consensus around well and truly higher for longer. And I think that does genuinely reflect there are different points of view on the Federal Reserve. There are officials out there talking about maybe we need one more rate increase. And you got people like Waller talking about cuts within three, four, or five months.

7:56And Waller is not one of your kind of air cadet kind of guys, right? He's one of the more hawkish members of the Fed's rate setting committee. So that's why these comments really stood out. So he's saying, even if inflation is still above target, maybe it's time to start cutting. So the market has got the bit between its teeth on this notion that rates are going to start falling pretty soon. And yeah, I mean, Jay Powell knows better than I do whether they've got that right. So again, it's not just Powell and the Fed. There's a similar opportunity this week for the European Central Bank, for the Bank of England to push back on some of expectations around cuts there as well.

8:32The market is pricing in about 1.3 percentage points of cuts from the ECB next year. For the Bank of England, it's more like 0.9 percentage points. This is a decent amount, but everyone's going to be sitting there eagerly with their little cups of tea and their mince pies saying, come on, have we got this right? Have we got this wrong? You know, give us a sign. Give us one of your kind of bizarre elliptical central bank comments to help us understand if we're on the right track. One thing I don't know if I totally understand about the ECB, Katie, that maybe you can enlighten me on is, you know, inflation in the Eurozone is really headline inflation that is including energy prices, which are kind of a key component to European inflation.

9:11They've really surprised the downside as oil prices have fallen globally. And the concern now seems to be core inflation. How scary does core inflation look in the Eurozone right now in your estimation? Yeah. So I think I'm right in saying the last headline inflation number from the Eurozone was 2.4%, which is certainly getting very close to target. And the broad idea around Europe is that it's much less able to withstand shifts in interest rates than the US is because so much more of lending is contingent on bank lending. Rather than going to the bond market, you go to your bank. So you're much more likely to get kind of floating rates whereby if the interest rate rises, then you immediately take a hit on next month's interest payment on your loan.

9:57So you don't have the same sort of mad system that you have in the States where you lock in mortgage rates for 30 years. 30 years. This is just like The American way. Completely alien to the rest of us. So we're just not as shielded from interest rate moves in the UK and in Europe as you are in the States. So much more sensitive. You're seeing more stress in economies like Germany's. Let's not forget a little while ago that Poland cut interest rates pretty hard. Yes, there may have been some kind of politics involved there. But nonetheless, three quarters of a percentage point in one go tells you this is an economy that probably is not doing so great.

10:39So, yeah, you know, there's a lot of investors out there who think that the eurozone quite possibly already is in a mild recession and that it's time for the European central banks to tap on the brakes and give companies and households and whatever a little bit of a hint that there are some rate cuts to come. But yeah, all central banks face the same issue, which is that if you give the market an inch, it will take a mile. And if you let the market think that higher for longer is over, lower for longer is back, hooray, then you will just go straight back to the inflation headache that you've been trying to cure.

11:14And just to bring it back to the US for a second, Jay Powell a couple of weeks ago made the comment that risks to the Fed's so-called dual mandate, which is full employment and price stability, the risks have become, quote unquote, more balanced, meaning that he sees both the employment side and the inflation side as comparably problematic, where it used to be the clear, clear, clear problem for the Fed. And I'd say also for the ECB and the BOE is like inflation is way out of whack and we got to really hammer this down. And now it's become two problems that are kind of intentioned, right? Inflation is coming down, but it's still a bit uncomfortably high.

11:53And there are signs of labor markets slowing. I mean, the labor markets don't look completely indestructible, though they do look pretty damn strong. and, you know, navigating what is becoming, you know, a growing tension between both of the goals that central banks want to target without tipping their hand to the market, right, and letting the market get ahead of itself. That's really hard. And I think it's going to be kind of an ongoing struggle in 2024. And we're going to hear a lot about, you know, so-called communication challenges from the central banks. Yeah, big time, big time. I mean, not that I think they're going to ask me to run any central banks anytime soon, but I'd much rather be a journalist.

12:31Thanks very much. It's really hard. Well, Katie, during Fed Day tomorrow, I really, really hope Jay Powell says something interesting because whether or not he says something interesting, I have to write a newsletter about it. And if he doesn't say anything interesting, I will be there straining, stressing, trying to produce words. He'll say something interesting. Come on, not all heroes wear capes. He knows the pressure you're under. Thank you in advance, Jay. I appreciate it. All right, Katie, We'll be back in a moment with Long Short.

13:04Welcome back. This is Long Short, that part of the show where we go long things that we like and short things that we do not. Katie, I am long Google losing an antitrust lawsuit to Fortnite maker Epic Games over Google's App Store. This is kind of a much covered, much heralded antitrust trial where Google was accused by Epic of cutting side deals with hardware manufacturers like Samsung and LG to basically prevent external app stores like Epic Games is from being on the Google platform, the Google software. And after just a couple hours of jury deliberation, Google lost in this trial and Epic won.

13:44I am along this in general because I do feel antitrust scrutiny has been too quiet over the last ever. but at the same time I do kind of feel torn because Fortnite is a dreadful game and if the eventual long-term outcome of this is that there's more Fortnite and more people playing Fortnite and more skin purchases within Fortnite I don't know if that's a better outcome for society all things considered. Is it a David and Goliath thing are we kind of rooting for the Fortnite side just because they're like not Google? I mean yeah that's another good point it's like Goliath and like a medium-sized Goliath.

14:19There's no David. It's a big kid punching a slightly larger kid. If I'm allowed, I'm also going to be long something. I am going to be long. Everyone loves crackdowns on greenwashing, right? You know, like claiming that your investment product is going to save the world or that, you know, your company, even though you're an oil company, you're doing your best to stop global warming, all this sort of stuff. In a way, it sounds sort of small beer, but I think it is quite fun that the UK competition regulator is looking into Unilever. They make stuff like household cleaning products and also like Dove soap and Lynx spray that teenage boys love spraying themselves in in enormous quantities and saying, you know, some of the packaging here that sort of with all the kind of green leaves on the bottles might give a misleading impression about how recyclable the bottle is or how chemically the contents are.

15:20And I just think it's a whole interesting new front in the war on greenwashing. You know, Katie, when I was a teenage boy, not terribly long ago, we used Axe body spray, which I guess is the same thing as Lynx. And if you were not absolutely reeking of Axe, it had to be kind of coming out of every pore of your body. You just weren't with it. You weren't cool i mean cool maybe but i can assure you i i own two teenagers one of them is a boy this stuff really stinks the house out and uh yeah they they do in indeed wear it in vast quantities well katie if there is anything to be long i am long us doing six months of these shows every single week minus your sabbatical.

16:05Is it six months? This year has really, really flown by, hasn't it? Yeah, it really has. It has simultaneously been a really long year. I need to go and sit in a dark room somewhere and also just zip by. Well, hey, listeners, we're grateful for you listening. If you've been listening since June, let us know. I'm at ethan.wuwuft.com. And if not, We're happy to have you too. Thanks for being here, Katie. And listeners, we will catch you again on Thursday.

17:00everyone else. Just go to ft.com slash unhedged offer. I'm Ethan Wu. Thanks for listening.