Getting inflation wrong

0:06Pushkin. The cool kids in markets are pessimists, but good news. Inflation in the US is lower, a lot lower. Don't know if you remember it being stuck at around 9%, but we've come right back down to 3%. Growth is good. It looks like investors might have to stop worrying and learn to love the rally. Can we all be happy? Are we there yet? This is the Unhedged podcast from the FT and Pushkin. Ethan, I'm afraid, is out today. I'm Katie Martin in London. I'm joined down the line from New York by Rob Armstrong, who writes the unhedged newsletter in New York. Rob, what are we going to do without Ethan to make us look clever?

0:48Well, as a professional unhappy person, I am here to reign all over your optimism, Kate. I don't know how I'm going to do it. I agree with you. The data is alarmingly good, but I'm going to find a way. Oh, God bless you. So, look, I mean, it does look like we're kind of there, right? Inflation has come back down to 3%. The sky hasn't fallen in. The central banks haven't hiked us into a horrible recession. Shouldn't we all just cheer the heck up? That latter point, it would be one thing if the Fed had done 500 basis points, also known as five percentage points of rate hikes, and we were now in the economic doldrums.

1:31But they've done that, and growth still seems pretty good. We are still adding jobs. Wages are OK. The consumer is still OK. The banks that have reported have told us that bad debts are not piling up at an alarming rate. Yeah. It looks like a healthy economy. Whisper it, but maybe. Whisper it after the Fed takes action to try to cool it off. This is a remarkable turn of events. So let's just dig down a little bit deeper into the inflation numbers. 3 % headline inflation was the number that rolled in last week. are you going to be one of these tedious inflation truthers off the internet who's going to tell me that actually, actually, it's much higher?

2:15No, it is coming down. I mean, if you take out the drop in energy costs and food costs, so-called core inflation is still too high. And it should be about 2%, right? It should be about 2 % and it's over 4 % still, but it's going the right direction. And if you look at what we're comparing to a year ago, the numbers were lapping, as it were, the trend ought to continue in the benign direction it's been going. So I'm not an inflation truther. This is good news. And the interesting thing is that the fact that this is happening at the same time growth is good, it means we sort of have to reconsider why inflation happened in the first place and what's going to happen to it now.

3:02So have central bankers won? Are they the heroes of the hour? Have they actually done this? Or has this got nothing to do with them? No, I think they've won by mistake, Katie, which is, I mean, I think that still counts in most sports. But the point is, because growth is still strong and inflation is coming down, it looks like what happened is a supply shock bout of inflation. We had this weird pandemic, We threw in a weird war on top of that. Prices took a one-time jump up. And that jump in certain prices took a couple of years to sort of bubble through the economy. You know, the guy who makes the metal had to raise the prices and then the guy who makes the nails and then the woman who builds the house and then the broker has to charge more.

3:48when you have a supply shock, it takes time to work its way through the different sectors of the economy. And it seems to have kind of worked its way through. So there's an argument that a few people were making that what the Fed did actually isn't the thing that brought the inflation down. It was just time. So our colleague, Martin Sanbu, has been saying for some months, if you guys will just relax, this problem will take care of itself. And nobody likes to hear that from a Norwegian socialist. Never. Never. But the guy is looking like he might have been right. And so maybe the Fed hikes, which you and I have been writing about continuously for 18 months, didn't matter that much.

4:35I mean, it really is a sort of professional embarrassment if you think about it. Yes. So given that, right, is it time for people who manage money for a living to just cheer up? I mean, look, the S &P is up 18%, 1.8 so far this year. The Nasdaq composite is up 36%. And still you have big investment houses like J.P. Morgan Asset Management, for example, saying this is too good to be true. We still think there has to be a proper recession to get inflation durably down at the target level. markets are priced for perfection. There's no room for error. There's got to be some sort of pullback. I'm not saying they're wrong.

5:18I don't have a crystal ball. But it's weird how people are determined to stick to this kind of bearish view that there has to be a recession and that markets have to pull back. I mean, do they? Human beings hate changing their minds. That is part of the story here. It's been painful for me to change my mind a little bit about this. My mind doesn't change as quickly as it did when I was a young man. But there's two threads you raised there that are both worth talking about. One is, are we getting a kind of inflation head fake? Uh-huh, yeah. And I think that's a bit of a legitimate worry because historically in incidents of high inflation, it's not been particularly stable, right?

5:59It's bounced up and down a lot in past, in at least the classic incidents of the 70s and early 80s. So are we getting head faked? Is it messing with us? Is it messing with us? Don't trust it. Yeah. Yeah. And the second thread you pulled out is the price to perfection point, especially for US stocks. They are still much more expensive than every other asset in the world. It's mad. They're reasonably expensive. And also, right, so there's a few tech stocks that obviously, as we've discussed before, are doing super, super well. Tech stocks are defensive right now. So they're doing well, even in an environment where interest rates have been rushing higher.

6:38But they've never escaped a recession before. They've only been defensive during COVID, basically. What if that's the anomaly? You know, if there is a recession, there's nothing to say that they do well again like they did in 2020 because it's just different. And primarily the thing that's different is interest rates are higher. It is interesting that we got this tremendously good report on inflation and stocks barely went up and bonds barely moved as well. Yeah. So short term rates are still up around 5%. Long term rates are still up, you know, the kind of four-ish, three, eight-ish long term rates.

7:18Yeah. And stocks were kind of like, we've been partying for six months already. We don't need to party just because of this news, right? So it tells you something about the valuation of the market and worries that inflation may be tricking us, that the two biggest asset classes didn't throw a celebration when these great inflation numbers came out. No, but they didn't head the other way either. And the way that one investor put it to me recently is, look, okay, you've got decent growth. You got inflation under control, brackets, not you, UK. We'll come on to you another time. We've got the consumers looking great.

7:57The job market, okay, weakened slightly, but it's still looking great. And I don't know if you remember, there was a banking crisis in the States in March that like no one talks about anymore because we've all just moved on. It just went away. You know, the Fed got its fire extinguishers out and just like made that whole thing go away. So, you know, so the Fed backstop is still there. Their willingness to extinguish fires is still there. So you've got the Fed put still in place. You've still got that, you know, that safety net from the central bank. You've got all that kind of positive news on the economic front.

8:33Yeah, manufacturing's got some cracks, this and that. But, you know, what's not to like it? It feels like a very uncomfortable place to be to be arguing with the scale of the rally that we've seen in risky assets so far this year. Yes. But for the first time in many years, I am getting paid to wait. So if I still have a few lingering worries about the valuation of stocks, I now get a real return on a credit risk-free treasury bond portfolio. So what we're talking about is Tina. This is such a beautiful segue. I want to say Tina is dead, and I don't mean that in a disrespectful way about Tina Turner.

9:18I mean it in a total and about there is no alternative. Yeah. We were talking about this, Ethan and I, last time around. We were talking about the demise of Tina. There is no alternative. There used to be a point where bond yields were so rubbish that you had no alternative, really, than to put your money into stocks and into other risky stuff. Tina, I'm afraid, is dead. Or maybe I'm happy to say Tina is dead. What is the new acronym that we use to replace Tina? I've been trying to make buying ordinary notes and debt securities, i.e. bonds, a thing. Yes. Someone sensibly pointed out to me that's actually bonads, if you include the and.

9:56So we decided not that. And we asked our dear listeners this time last week for their suggestions. Some of them, listeners, were awful. However, the gold star goes to Kevin Gordon from Charles Schwab, who came up with Barbara. Do you know what Barbara is, Rob? I don't. Bonds are really back and really attractive. How do you like that? I like it. And I think it's going to take off. Yeah. The Barbara trade. I think we can make it a thing. Why aren't stocks going up? Barbara. Yeah. Yeah. Blame Barbara. if you want to be like super zeitgeisty you could I guess shorten it to Barbie you're the pink paper we're the pink paper Bonds are really back in earnest in earnest it's happening I mean so look Barbie, Barbara perhaps listeners can again tell us which they prefer but I think this can work we will be back in a minute with Long Short Okay, now it is time for long short, where you can be long or short of whatever you like, which means that you either love it or you hate it.

11:08It can be anything, bond, stock, a sport, whatever you fancy. I am going to be long credit trading. So corporate bonds, the way that they change hands has been stuck in the dark ages for like ever. They're like largely traded over the phone. It's a little bit pathetic. Now, Citadel Securities, run by Ken Griffin, has started getting into this game and facilitating trades in corporate bonds. So it sounds like maybe this whole industry is going to get dragged kicking and screaming out of the dark ages. Rob, what have you got? I'm going to really scandalize you, Katie. I am going to be short the dry martini.

11:49Oh, for heaven's sake. And I'm telling you why. Now, I make it a practice to drink my weight in dry martinis every year. So this is a big conversion. But last night, it was a hot, sweaty day in New York yesterday. And I went to one of our local speakeasies, a place called the Commerce Inn, and their house martini is half vermouth. and it served very cold. I know this sounds chilling, but on a summer day, sweltering heat, you don't want to try to cool yourself off by drinking pure gin. No. I've tried this. It is a bad idea. And the half vermouth martini was delicious and I drank several and I felt refreshed.

12:32Can I ask what's the going rate for a martini in New York City these days? You don't even want to know. I think if you pay$19, you're getting a bargain. Ay, chihuahua. It's a big drink, but it's$19. Yeah. Well, look, it stops you from drinking loads of them, which is probably a good thing. Speak for yourself. Yeah. Rob, always a pleasure. Talk to you soon. Okay. Thank you, Katie. That's it for now. We'll be back on Thursday.

12:58Unhedged is produced by Jake Harper and edited by Brian Erslatt. Our executive producer is Jacob Goldstein, and we had additional help from Topher Forhez. Cheryl Brumley is the FT's global head of audio. Special thanks to Laura Clark, Alistair Mackey, John Schnarz, Eric Sandler and Jess Trulia. FT Premium subscribers can get the Unhedged newsletter for free. A 90-day free trial is available for everyone else. Just go to ft.com slash unhedged offer. I'm Katie Martin. Thanks for listening.

13:39We'll be right back.