Central bankers do nothing. Markets respond

0:06Pushkin. Those heady days when investors were convinced we were going to get rapid fire rate cuts from the Federal Reserve are well and truly over. This week, the Fed suggested that maybe we'll get one cup this year, maybe two. But today in the show, we ask, are we sure we're going to get even that? Like, is zero an option? This is Unhedged, the markets and finance show from the Financial Times and Pushkin. I'm Katie Martin, a markets columnist at the Financial Times here in London. And I'm delighted to welcome to the podcast today, a full on central banking nerd, Chris Giles. Hi, Katie. Chris, tell me, would you like to be a central banker?

0:47Is it an easy job? No. You have to make these quite big decisions about what affects everyone's finances, and you don't really know. And if you get it wrong, and it's obvious you've got it wrong after the fact, everyone has a go at you. Yeah, people just sort of fling poo at you constantly and tell you you're wrong about stuff. There's so many armchair generals, armchair Fed members, right? I mean, I love to look at what the markets have expected the central banks to do. So they say, well, their forecasts aren't working, but the market is literally a forecast of what rates are going to be. And they've changed their minds so many times over the last two years.

1:22It's true the central bank forecasts haven't worked at all well in the last few years. A bit better now than they were in 2022. But everyone's been in the same boat. There's a whole lot of wrongness to go around. But so tell me, what did we learn from the Fed this week? They did this weird thing where they suggested that we're going to get one and a half rate cuts this year. Now, you don't really get half rate cuts in real life. So what are they saying? You don't. And it's where the median, which is the median expectation of their committee, there's 19 people on it, was for one rate cut. But actually eight of them suggested two.

1:59So it was pretty close. So they can't decide. So about half think two, about half think one, and a few think zero. So zero as we started the show is perfectly possible. We were thinking six at the start of the year. That was where markets were. Markets were six at the start of the year. At the time, the Fed was about three. The Fed sort of stayed, you know, sanguine, saying three, three, three, three, three. And now it's one or two. Yeah, so the Fed's only moved by like one and a half cuts, right, in terms of signal of expectations. But the market really got the wrong end of the stick and ran really hard with it, right?

2:35So there's been this kind of big readjustment as markets have come into contact with reality. Why has that process been so difficult to read? And what is it that now that could actually force the Fed's hand to do something? Well, it's all about data and the terrible term data dependence, which just means that you go along, you think something, the data comes in, proves you wrong, and you change your mind. So haven't got a scooby. Haven't got a scooby. No idea what's going on. start of the year we just had three really good inflation numbers in the US. In all ways it was better than expected so this is why the market thought okay inflation's over growth is back.

3:18Hooray we have defeated inflation mission accomplished. Exactly they were they were on that aircraft carrier outside back with the banner and then we had three really terrible inflation releases. And then we had the fourth one, we've had five in the year. The fourth one was okay. That was for April. And the May figures we got on Wednesday were pretty good, actually, really good. So the key numbers there was that headline US CPI inflation. It's ridiculous that we have to go into these details. But the headline CPI inflation in the month of May was zero. There was no inflation. Torset prices were the same as in April.

3:58And core, so excluding food and energy went up by 0.16, which if you make that into an annual figure means two. So that's the first time in about a year they've actually been at their 2 % inflation target for one month. So let's not get excited. It was one month. But it was one very good month. Yeah. And this year has shown you that if you extrapolate too much from one month's number, then you can get smacked in the face. Yeah, exactly. And that is what the Fed was basically saying. They were saying one month. Now, they got the figure, again, they had it a little bit early and they were able to change their forecasts.

4:37But it's not clear whether the members really did or they thought, oh, it's just one month. I'd like to see a little bit more. So that's why I think we shouldn't look at these forecasts of the individual committee members about how many rate cuts they think is appropriate this year without some scepticism. How much notice do they put on this data? and if there's a few more months which are likely, will they change their mind? The answer is almost certainly yes, because they're not in a situation where they feel they can make a long-term forecast, be confident it's going to be right, so that monthly data they can just go, monthly data, who cares about that, it's just a blip.

5:15The thing is, it doesn't matter how many times, whether it's the Fed or the Bank of England or the European Central Bank or who it is, they say, right, these are our forecasts. Please don't write this in stone. this is not a promise this is just kind of what we think is going to happen next and everyone in the market smiles and nods and said this is a promise like they just cannot get this across to investors that this is just their best guess in this current situation yeah and their best guess if you look at their record recently it's been less volatile the markets but that's partly because they're not having to make a best guess they do it every six weeks or so so they don't go up and down so much but their best guess has been swinging around just like the rest of us and that's because it is really uncertain we don't know whether we've fully defeated inflation we don't even really know what defeating inflation is we're having a big argument about what caused inflation which is overblown because a lot of it we understand and so we were sort of talking about the second order things about people in economics always get overly heated about these things but we don't understand it fully and so it's quite hard to make forecasts that you're going to rely too much on.

6:23And I think if you look across the Atlantic at the European central banks, both in the UK and in Frankfurt, where they've sort of explicitly said, because our forecasts have been so terrible recently, we're going to put less weight on them. Now, the ECB has actually recently said, right, we're putting a little bit more weight on them. So even though they had a terrible inflation release for May, they still cut interest rates this month. And that was a That was maybe a sign that they're getting a little bit more confident that they can ignore one month of data. But you could tell from what the central bankers were saying afterwards, that A, they didn't feel very comfortable about doing that.

7:04They'd sort of boxed themselves in. Yeah, they painted themselves into a corner by saying, this is what we're going to do, everybody. Exactly. And B, they sort of felt that, OK, we'll do this, but now we're going to be data dependent. We can do one and say it's because we like our forecast, but we can't do more than that. Is it just objectively harder for central bankers or for anyone else for that matter to figure out what's going on with inflation now? Because it feels like everyone's having a really hard time with it. Is that because everyone has got stupider or because inflation has got harder somehow?

7:35Oh, it's because the world is more complicated and more difficult as we came out of the pandemic. So this isn't because we're that something fundamental has changed in the world. But what we used to have to do or what people used to have to do when they forecast was basically try and work out how much people are going to spend. The more you spent, the more inflationary it was going to be. But now you've got to look at the supply side as well. And supply side changes, whether it is people suddenly buying massive amounts of goods and no services in the pandemic or that changing or supply chain shocks or Russia suddenly cutting off 90 % of its gas supplies to Europe.

8:13These are big things. And now we're moving into a world where supply shocks are getting bigger than they have been in the past. and that just adds not just a little extra dimension, a massive extra dimension. And then we're thinking about a potential trade war. This is what's keeping everyone up at night. I'm thinking, actually, this forecasting game is going to be pretty difficult. So it's not that we're getting stupider. No, we might even be getting smarter, but just it's getting harder. We just don't really know. But that's the same as we started with, isn't it? So going back to the Fed, when do we get this probable first cut?

8:48And he was talking about, Jay Powell, chairman of the Fed, was talking about a couple of tests to determine when he might pull the trigger. They were effectively, one, we grow increasingly confident that inflation is coming down to its 2 % target in a kind of durable fashion. And the other is that the jobs market goes belly up. When do you think either of those things might happen enough to actually force his hand? Well, it doesn't look like, I mean, you'll know this better than me, but the jobs market doesn't look like it's going to hit that belly up signal. We just again this month had some very strong payroll numbers, really strong.

9:21Yes, unemployment's been ticking up, but it's 4%. So it's still very low in any historical context. So let's leave the B aside. And so it's all about whether you, in terms of what might happen in the next few months, it's all about whether we get some more really good inflation figures. So I think you could say that the September meeting in mid-September is possible. I think the July meeting is impossible because we're just not going to have enough to say it's durable, what we're sure we're getting down to 2%. But if come September you've had another two really good inflation releases, so you can say, look, we've now had a quarter where we've been at 2 % or a quarter where we...

10:03Right. Then I think you can say, yeah, it's looking a lot better now. And so the other classic get out that the central bankers have is the one that the ECB used this month, which is to say we're dialing back the restrictiveness. So we've still got our foot on the brake. So we're still, you know, getting rid of inflation. We're just not pressing quite as hard as we were. Yeah. And so it's OK to take a bit of a risk in these circumstances. Not all ducks have to be in a row. Right. Just a few of the ducks. But you spend a lot of your time talking to economists, talking to people in central banking circles.

10:38I want to know a couple of things. Firstly, do they really not care about the US election? Would they be prepared to move rates right ahead of the US election? And second of all, how much do they think about legacy and about not being the squad that messed everything up? So I think they certainly don't care about the US election to ever say that they care about the US election in a meeting where the transcripts are going to be published in however many years, eight years' time or so. So you'll never see evidence that they care about it. And I think that's broadly correct, although it doesn't mean they don't think about it.

11:20So they will think about what is the best strategy. And it frankly doesn't matter if you're going to cut rates in September or December. If there's only going to be one in 2024, it wouldn't really make a huge difference. So I could imagine the Fed will be thinking about what would a Biden administration or a Trump administration come November or come January next year look like. And I don't think they'd ever try and time things that it made one more likely than the other. But they wouldn't be averse to having that as a consideration. So I think, you know, let's talk about practically, does this make September more or less likely?

11:59If you think elections really matter and they really want to hibernate, then they're not going to go in September. But the Fed has in the past done rate cuts or rate moves in the September before another election. So I don't think we should rule it out on those grounds. And to the very limited extent that I am positive they would prefer Biden administration than the Trump administration for their own lives. lives, because it will be quite miserable for Fed officials, I think, under a Trump 2 administration, or could be, there's a risk of that, then September looks a little bit more likely. And on the legacy point?

12:41Oh, they care enormously about legacy. Legacy is absolutely everything to them. So the last thing, this is why they always go on and bang on about the worst thing could happen is that if we started to cut rates and then we had to put them up again. And I just don't understand that as an economist or the economics. I don't understand. I just don't get it. But so many of them say it's on their mind. They don't like being wrong, whereas we're really good at being wrong. We love it. We love it. Speaking of which, I'm going to give you an opportunity to be wrong. September or December? September. Oh, really?

13:14I'm going to say September too, because that was my initial bet was September this year. I've got a pint of beer riding on it. If we get some bad inflation figures, then I'll be wrong well before September. You can easily be wrong next month. These numbers have been bouncing around. Well, thanks for grabbing that opportunity to be wrong. You can be wrong again in a minute with Long Short. Excellent.

13:45OK, now it's time for Long Short, that part of the show where we are long a thing we love, short a thing we hate. Chris, you haven't done this before, but it can be anything. Take your pick. So I'm going to be long transatlantic interest rate diversion. Oh, you are such a nerd. I'm so boring. I think that people say that you can't have European interest rates much lower than the Fed and it's going to cause lots of trouble in markets. I don't buy it. Why do people get their niggers in such a twist about central banks going in different directions on different sides of the Atlantic? What's supposed to be so bad about it?

14:18Well, normally they think there's going to be some sort of currency market turmoil that if you have rates going down in Europe, then returns are going to go there, but you've got high rates still in the US, then money's going to fly across the Atlantic to the US and the euro is going to go down, the dollar is going to go up and it's going to cause a whole lot of problems. I kind of buy it to the extent that one thing that the European Central Bank and all central banks are sensitive to currency fluctuations, right? But in theory, if the euro goes down, then that should push inflation up in the eurozone by dint of the fact that the European zone imports stuff in dollars.

14:56And so prices go up, yadda yadda. But not many. You know, the European zone is big. And most of its imports and exports are to itself in other countries. Like the US, these sorts of currency movements don't have very, very large inflation effects. And it's easy to exaggerate them. So you're just not buying that it's a problem? Not really. So I, on a slightly different note, I am long the end of exam season. Hurrah! Oh, thank the Lord. Your kids are a bit older than mine, so you know the trauma of having kids going through their GCSEs. You'll have drunk children now. So my very strong advice to all listeners, if you're in the UK, avoid your local park from roughly 4.30pm on Friday, because most of the kids will be coming out of their final GCSE round about then.

15:46it's not going to be pretty you're not going to want to be around so i'm long the end of exams short parks short parks i am going to be i'm going to go for an election one i'm going to be short you've already had one i haven't had a short one oh no you don't have to have a short one go on then i'll let you have another one okay i'm going to be short nigel farage in clacton oh i think he's a busted flush you don't think he's going to win no i think he thinks he's got more support than he has. Oh, now that's a braver one than your very boring transatlantic interest rate diversion one. But Nigel Farage to lose, September cut, short parks, you've heard it all here first, listeners.

16:26We'll be back with similar dollops of wisdom for you in your feed on Tuesday, so listen up then. Unhedged is produced by Jake Harper and edited by Brian Erstad. Our executive producer is Jacob Goldstein. We had additional help from Topher Forges. Cheryl Brumley is the FT's global head of audio. Special thanks to Laura Clark, Alastair Mackey, Greta Cohn, and Natalie Sadler. FT premium subscribers can get the Unhedged newsletter for free. A 30-day free trial is available to everyone else. Just go to ft.com slash unhedged offer. I'm Katie Martin. Thanks for listening.

17:11We'll be right back.