Federal Reserve puts on enormous party hat

0:08A great moment in history has arrived. Rob Armstrong was right about something. Quite against the run of play. Shush, Rob. Quite against the run of play, the Federal Reserve has cut interest rates, hooray, from the highest level in decades. And for the first time since the pandemic. And what's more, it went large, cutting by half a point precisely as my esteemed colleague had predicted. Now, what kind of voodoo is this? Does the Fed know something horrible we don't? Cutting by half a point is normally a crisis measure, a cry for help. Should we panic about a recession? And really, Rob was right.

0:49End times. Today on the show, we're going to explain how come investors are ignoring the usual script and taking this bumper cut as a good thing. This is Unhedged, the markets and finance podcast from the Financial Times and Pushkin. I'm Katie Martin, a markets economist here at FT Towers in London. And listeners, I must tell you, the saddest of things has happened. I am joined by Rob Armstrong, Lord of the Unhedged Newsletter. But the sad thing is he's dialing in from his sickbed. Rob, I'm sorry you're poorly. I am poorly. It's terrible. But on a 50 basis point day, the dead shall rise from their graves.

1:30The angels shall sing. And we're all going to talk about it. Yes, strong Barry White vibes I'm getting from this voice you're busting out today. So as you say, half a percentage point from the Fed, that's 50 basis points in market money. Normally, central banks love being super boring, and they normally move by quarter point increments. So, I mean, was it the shock of being right about the 50 basis point thing that pushed you over the edge into sickness? It could have been. I'm so accustomed to getting this wrong now that it was really paralyzing. However, I think, you know, you mentioned earlier, why is the market kind of taking this in stride and seeing this as a good thing?

2:15And I think it's a bit of a communication success by the Fed in that they told the story about this, that they're not doing this because they have to, because it's an emergency. They're doing it because they can. And the reason they can is because they've kind of beaten inflation, right? So for people who, unlike us, have a life and don't sit around watching central bank press conferences, the way this works is they do the decision. They say, here you are, here's your 25, your 50, whatever basis points are on hold. This time around, it was 50 basis points. And then just a little while later, there's a press conference where the chairman, Jay Powell, gets up in front of like all of the kind of most pointy headed Fed journalists in the world and feels whatever questions.

2:59There's a statement and then he feels whatever questions they want to throw at him. And this for him was the point of highest danger because the risk of giving the impression somehow that, yeah, we're really worried. That's why we've done 50. That was a serious risk, right? But instead, what happened? Well, right from the press release announcing the 50 basis cut, they tweaked the language in the press release so that it was more affirmative and strong on the topic of inflation. We're really pleased how it's going on inflation. And then in the press release, I mean, in the press conference, he just reinforced that point again and again.

3:39The line he repeated was, the labor market is fine. It's healthy. It is at a good level. We don't need it to get any better. We're not trying to improve it. But we have the freedom to make sure it stays as good as it is. And that message seems to have gone through. Markets didn't move yesterday afternoon. and as a very, you know, opening minutes of trading this morning, stocks are up. So that message seems to have gotten through. Yeah, that is skills, actually. You know, I will hand it to them because, you know, it's, we've said this before on this podcast, like it's so easy to like throw stones and peanuts at the Fed or the European Central Bank or the Bank of England or whatever and say, they messed this up.

4:23But like this stuff is hard. Getting the markets to come away with that sort of impression is not to be taken for granted. It's not to be taken for granted. I agree. However, I will note, anytime you're trying to spin a narrative and you want people to believe it, one thing that really helps is if the narrative is true. And in this case, I think it broadly is. I think inflation really does look like it's whipped. it's really either at or very close to 2 % and look with an unemployment rate of 4.2 % and basically no increase in layoffs and the economy still adding jobs I think the economy is pretty good so it's not like he had to spin a magical tale of unicorns and wizards here he just had to you know make a case based on the facts yeah and and that kind of goes back to the fact that the Fed is not quite like other central banks in that it has to look after inflation, but it also has to look after the jobs market.

5:25And so, you know, again, the risk is that you come away from a decision like this and think, well, you know, those little cracks that we've seen in the jobs market, maybe they're the start of something really big and hairy and awful. But he seems to have massaged this one away. Indeed. Impressive performance. And so the other thing they do in this press conference is they give the general public and sad nerds like us a little bit of a taster about what's coming next from the Fed, right? So they're always like central bankers are at pains to say none of this stuff is a promise. This is just our kind of best current understanding of the state of the universe.

6:04But so then you end up with this thing called, drumroll, the dots. The dot plot. The dot plot. But explain for normal people what the dot plot is. Okay, so it's kind of a grid. And along the bottom are the years 2024 through 2027, and then another column for the infinite future. And then there's a range of interest rates going up and down on the side. And every member of the Monetary Policy Committee puts a little dot in each year column where they think the rate is going to be in that year. Cue much speculation about what all this means, how they've changed their mind since the last dot plot, and, you know, the implications of all of this.

6:54Whose dot is whose? We'll never know. They don't reveal whose dot is whose. That's an important point. And, by the way, Katie, according to everything we hear out of the Fed, having invented this device, which was supposed to increase clarity and make everyone's life easier, everyone in the Fed now hates it and wishes it would go away because it just causes endless idiotic little niggling questions from people like me and you. But once you've invented something like this, if you take it away, people get upset. So you look at the dots and you look at what Jay Powell was saying at the press conference and what does it all add up to?

7:32Does it mean that like, okay, they've started with 50 basis points. So like 50 is the new 25. Get used to it, boys and goes? If you look at the dot plot and their kind of aggregate expectations of where rates are going to go, it is not that 50 is the new 25. The implication is that the rate of cuts is going to be very measured, or might I say stately, from here until they reach their target. Right, right. And, you know, another point to mention here is where they think they need to go is very important. That's the kind of last part of the dot plot. It's like, where should interest rates be when everything is normal again?

8:15Because that will happen one day. Yeah, that will happen. They think it's going to happen sometime around 2026, 27. We'll get to what's about normal. And they're looking for about 3 % rates in the long run. And that's, so that's where we're going to, just to set the context, we cut from five and a half percent to 5 % yesterday. And the map of the dot plot shows us moving towards a little under 3 % over time. And it's a matter of how quickly are we going to get there? And along the way, are we going to change our mind and decide we have to go somewhere else? Yeah. So is there a kind of joyful hope that maybe the Fed could be like boring again, and it can just sort of do 25 basis points here and there and just take this kind of glide path lower in rates that doesn't get people excited anymore?

9:09Well, this is the problem about the future, is that it is hard to predict, and particularly hard to predict with interest rates. The issue is that the economy, the structure of the economy has changed a lot in the last couple of years because of the pandemic and for other reasons. So that final destination point I talked about, which economists call the neutral rate, which is the just normal, everything is boring and steady rate of interest in the economy where everyone has a job, there's no inflation, everything's cool, the neutral rate. We don't know what that number is. And Jay Powell has this line about it.

9:48We know it by its works. and what that means stated less calmly is we know it when we screw it up in other words we we hit it we go past it we we push interest rates above the neutral rate and stocks and stocks have a big puke and the economy starts to slow down and people get fired or we travel too far below it and inflation starts again. So like the Fed over the next couple of years is like walking down this passage in the complete dark and it knows it can't touch the wall on its left or the wall on its right. Right. But it doesn't know the shape of the passageway, what direction it's supposed to go.

10:31So it's just like, well, I sure hope we're going this way and hope it doesn't hit too low or too high along the way. Hope it doesn't just walk into a wall. The history of interest rates is history of feeling your way along in the dark. Rob, that's the most lyrical thing I've ever heard you say. Isn't this poetry? It's because I'm so ill. These could be the final words of a dying man. What meds are you on since it's cold you've got? This could be my legacy, Katie. I feel like we should kind of wrap up quite soon before you just like expire during the recording. I do, as much as I like you. I'd like to have a few words with my wife before I shove off.

11:14But I will ask you, are we ever going back to like zero interest rates, do you think? I feel like I've been asking a lot of questions. This is a great question, Katie, but let me push it back on you. We had this wild period in the last decade where there was like a gajillion dollars of sovereign bonds issued at a negative interest rate. I think that was something like$18 trillion or something. It was bonkers. And it was like the Fed funds rate was up against zero. Money was free. We were all in Silicon Valley inventing startups, whatever, doing our thing. Do you think we're going back to that?

11:52Like once this incident, the pandemic and everything after is over, are we going back? I mean, I can't see it. I buy the narratives that are kicking around about inflation now being structurally higher, right? There's a climate emergency. There's a global defense emergency. There is all sorts of things that governments need to spend lots of money on, borrow lots of money for. all things being equal. And then there's the whole supply chains thing after COVID and with geopolitics. And the world is getting older, right? And so when old people create demand for savings, that drives interest rates up, right?

12:27Ah, old people. Yeah. Old people. But I think also before we wrap up, we should note that although you were right about 50 basis points, I was right about the timing. I said on this here very podcast back in, I think it was June, 2023, that, not 24, 23, that the Fed was not going to cut rates until the third quarter this year. So what I'm saying is, I'm the genius here. You're just a kind of hanger-on. You're basically Cassandra. You're basically Cassandra, doomed to see the future and not be believed. I'm going to... Do I have the right mythological figure there? I think that was Cassandra. Absolutely no idea.

13:04But I'm going to set up a hedge fund called like, Hunch Capital, where I can invest your money for 2 and 20 based on nothing but pure hunches. Do you want in? Because like my hunch on that, your hunch on the other, I think we're going to make good money. We could. We could be rich people, Katie. But I will answer your question seriously. I think interest rates are higher now. We're not going back to zero. I will end on that serious point. Governments are spending too much. They have to spend too much. There's loads of old people. The green stuff has to be funded. Productivity might be rising, possibly because of AI.

13:43We are going into a higher interest rate world. And by the way, the Fed thinks that. If you look at the history of the Fed's view of what the long-term normal interest rate is, that has been steadily ticking higher over the last year and a half or so. So rates have come down already pretty hard, but don't get yourself carried away with thinking that we're going back to zero because ain't, I mean, I can't say. Ain't gonna happen. Ain't gonna happen. On that bombshell, we're going to be back in a sec. with long short okay now it's time for long short that part of the show where we go long a thing we love short a thing we hate rob i feel like you should go first before you completely lose your voice well i'm i'm gonna go short well-being and i say this not because my well being is poor right now, but because of an article our colleague Joshua Franklin wrote in the Financial Times yesterday that says, I'm quoting here, JPMorgan Chase has tasked one of its bankers with overseeing the company's junior banker program, a response to renewed concerns about working conditions for young employees.

15:00And it goes on that this poor person is going to have to make sure all these young investment bankers are happy and have work-life balance. I think investment bankers owe it to the rest of us to be miserable. Right. They make a lot of money. They are the lords of the universe. They should not be happy. Their well-being should be awful. And that's what you're getting paid for. Right. So I think JPMorgan Chase is doing the wrong thing here, and they need to appoint a banker to oversee the, what's the opposite of well-being? Unwell-being of their junior bankers. You're a very, very mean person. You just want everyone to be sad like you.

15:45No, if you want to be happy, become a journalist and make no money. If you want to be rich, become a banker and, like, get divorced and have your kids hate you. It's just the normal way of life. Well, I am long European banking merger drama. Whoa. if you've missed it, the German government is like quite scratchy and unhappy about a potential takeover of Commetz Bank by Italy's Unicredit. The talk of the town, everyone is kind of, you know, huddled around in bars in the city asking like, how the hell did Unicredit manage to amass like a 9 % stake in this thing? Like that doesn't seem like a good strategic move.

16:27There's a lot of excitement over the motives. My interest here is that this is just like the good old days of European banking mergers with like very important European bankers wearing gilets under their jackets, going around in like big fast cars and, you know, chatting away on their mobile phones and being masters of the universe. I just wish they would get along with it. As far as I know, in continental Europe, there's actually more banks than people. Yeah, it's like sheep in New Zealand. You've just got... They just need... I mean, as long as I've been in finance, people have been rattling on about how banking in Europe was going to consolidate.

17:04The industry was finally going to make some money and it was going to be able to compete with the US. And then it's like, you know, some Germans get mad at some Italians. It never happens and the cycle turns again. Yeah, it's like, we want consolidation. But no, no, no, no, no, not like that. Not like that. Anything but that. And I am here for the drama, is all I'm saying. Right on. I love it. OK, listeners, we are going to be back in your feed on Tuesday if Rob makes it that long. But listen up anyway, wherever you get your podcasts. Unhedged is produced by Jake Harper and edited by Brian Erstad.

17:38Our 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, Alistair 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.