High interest rate anxiety

0:06Pushkin. On the very first episode of this here show, Katie Martin and I made a bet about when interest rate cuts were happening in the US. I bet for the first quarter of 2024. Katie bet for the third quarter. Well, I was wrong. Today on the show is Katie Wright. This is Unhedged, the markets and finance show from the Financial Times and Pushkin. I am reporter Ethan Wu here in the New York studio, joined by the woman that wins all the bets in her life, Katie Martin in London. I will have you know, I received emails telling me I was an idiot. And who's laughing now? I'm sure those emails were from one Robert Armstrong.

0:50They weren't, but I keep all of his in a special file. Katie, why was I wrong? Riddle me that. I said Q1 and it wasn't Q1. What happened? You got like a lot of people sucked into this narrative that was very popular at the time that a big recession, big, scary recession was going to come to the US and the Fed would have to cut interest rates in response. Dude, where's my recession? It's simply not happening. If anything, and we can discuss this in more detail, the US economy looks like it might be overheating. Yeah. You know, that when when that first prediction was made, your your bet, which you lost just to reiterate, which was like June last year, we're in a whole different environment now.

1:33It's really quite extraordinary how things have turned around. It's amazing that we titled the first episode of the show. Where's the recession? Like a question that seems like truly foolish in hindsight. But no, I mean, I remember it well. I remember obviously the yield curve has been inverted, which is the classic recession indicator that's been wrong. There was prolonged weakness in manufacturing that potentially could have signaled a recession. And actually just last month in March, we've gotten the longest non-recessionary streak of US manufacturing contraction ever, ever. There's never been this much weakness in US manufacturing without a recession.

2:09And it just turned out this time was different, right? All the classic signals across history that you could have relied on didn't tell you that much. You had to have a broader view of what was going on with supply chains and with the labor market and immigration and all this different stuff that kept the economy going so strong. Yeah. It really feels like since the pandemic, just a lot of stuff has changed. A lot of stuff about how inflation works and how central banks respond to it has just completely changed. And we're still getting used to this new world. So just to recap a tiny bit, there was some pretty punchy inflation data in January.

2:47And everyone said, it's January, seasonal, let's just ignore that. And then there was another strong number in February. And something quite odd happened because the market totally took it in its stride. And it was this kind of look, you know, we can all weather stronger inflation, because it's a good sign that the economy is looking nice and healthy. What has changed now is that we've had a third slightly punchy inflation reading. And then all of a sudden, screech of tires, everything has changed and everyone is ripping up their forecast for rate cuts from the Fed for this year and markets don't like it and everyone's in a tiz.

3:26Yeah, that's a perfect summary. I mean, it really shows kind of how far we've come, right, that We flipped from in June of 2023, recession being the kind of primary concern to now in April 2024. We're worried about inflation all over again. And, you know, part of the case bolstering inflation fears is actually just how strong the economy is. Right. So we got earlier this week a really strong retail sales report, which is feeds right into the GDP data. Other activity data has been has been good. Industrial production, manufacturing are both picking up. We get month after month after month of like solid, solid, solid employment data.

4:04I mean, how does the Fed cut into this? Exactly. It just doesn't add up. And one thing that's really notable to me is so obviously the situation in the Middle East is just horrendous. And markets again have been like, whatever, I'm sure they'll figure all this out. I don't know if that's complacent or not, but that's been the market reality. Whereas, you know, enter stage right, the mighty U.S. consumer, and we get this kind of punchy U.S. retail sales numbers earlier this week. And the market like flips out the following morning in Asia and Europe because suddenly it says, hang on, the U.S. economy is just too strong.

4:44The Fed just might not be able to do this. Yeah, I want to talk about the market mood in just a second. But before that, we should address like the economic bears are still out there. They always are. Oh, yes. And, you know, I think if you were more bearish on the economy, what you would say right now is, well, hey, look at credit card delinquencies. Look at auto loan delinquencies. Interest rates are starting to bite, especially for poor consumers. The CEO of McDonald's, who should have a good sense of how U.S. consumers are feeling, is saying stuff like this is a challenging consumer environment.

5:16And a bunch of stuff like that. There is weakness out there. It's palpable. It's showing up in some of the data. we should expect that to start to eat away at activity over time. That's the bear case, right? That there's weakness on the periphery and overtime is going to start to creep into the core of the economy and drag us maybe not into recession, but certainly, I mean, we're at like 2.8 % GDP forecasted for the second quarter right now. 2.8 is too hot. That's not going to last. It's going to come down. Yeah. The thing with that is I'm not dismissive at all of that as a concern. But you can pick apart any data release that you want, whether it is non-farm payrolls or inflation or retail sales or something like auto loans and household debt and all that stuff.

5:59You can find pockets of weakness. Absolutely. But is it unusual for a hot US economy to have, you know, different effects on different slices of the population? No. So I'm not convinced that it moves the dial. Now, you know, maybe the bears that are still like clinging on with their tiny tiny fingernails. If bears have fingernails, they probably have claws. Anyway, not a vet. You know, they're still clinging on and that's fine. And they might still be right. And maybe this kind of three months on the bounce of upbeat US inflation data, maybe that's the blip, not the previous kind of downdraft that we had at the back end of last year.

6:39Who knows what is a blip? You don't know that you're in a blip until it's in hindsight. So So who knows what the reality of the situation really is. But certainly what the bond market is telling us and what rate expectations that are sort of squirreled away in financial markets are telling us is that the Fed certainly can't go in as hard as previously expected. So start of this year, markets were looking for six, maybe even seven rate cuts this year. Madness, even like even without a recession, there was this idea that they were going to cut that hard, which felt too much to me, even at the time.

7:14Now the market is saying, we'll get one, maybe we'll get two if we're lucky. And that, I don't know, that just changes the game. Yeah. Let's definitely talk about that market mood, right? I mean, I think you can kind of carve it into three general regimes since we recorded our first episode of this podcast, which is how I delineate all time in my mind. So, I mean, after we published Where's the Recession in June 2023, stocks were flat to actually down. There was a lot of recession pessimism. People were kind of pulling back and being cautious. Then since October until like March of this year, it's been like NVIDIA, AI growth, rate cuts.

7:56It was truly like the market expectation was for the best of all possible worlds that you were going to get. Very cooperative inflation, very strong growth, productivity enhancements because of AI, never-ending NVIDIA earnings beats to infinity, and stocks were going to go up and up forever, and everything was rallying. And that sort of ended, I would say, around early to mid-March. And since then, we've been flat and maybe a little bit down. NVIDIA is off 10 % from the peak. The S &P is off 3%. That's not a sell-off, right? That's caution. But you've definitely had a palpable shift from the kind of ebullience, the untrammeled ebullience of the last couple of months.

8:35Yeah. I think investors overdid it a bit, to be honest. Late last year, start of this year. So yeah, it's kind of natural for a bit of steam to come out of this. But obviously the question is, is this the start of like the big one, you know, the bears that are there clinging on with their nice painted fingernails? Are they on the cusp of being spectacularly right? And our market is going to really suffer from here? Or is it a blip? Is this something that we can wear? Maybe we just kind of float around current levels on stocks for the rest of this year. But yeah, just to really underline the point, the whole mood has changed.

9:13It's been a big vibe shift. I feel the need to say, it's not that bad. You know what I mean? It really, really is not. Yes, ideally, inflation would be closer to two. Yes, ideally, there would be a clearer Fed outlook. Yes, ideally, there would not be a gigantic potential cluster mess in the Middle East. But from the perspective of a U.S. investor, growth is good. Earnings are good. The Fed is not talking about interest rate increases, right? They're talking about higher for longer, not jacking rates up to kill the economy. The most catastrophic fears, with the potential for the Middle East to become worse, obviously, some of the most catastrophic fears of even June 2023 are not on the table right now.

9:52And that's a good thing. I think right now is just a gear shift from the best of all possible worlds to a world that is decent as opposed to the best thing possible. Right. And so if your expectations were set for the best things possible, that's going to feel like a disappointment. But like on the whole, it's not that bad. Yeah. For disappointment, Ethan, if I can leave you with no other advice. The Unhedged podcast, consistently disappointing. So, Katie, I suppose in conclusion, I lost you one. I owe you a beer. However, the question is, Katie, are we both going to be wrong ultimately, or is it just me?

10:29I mean, your wrongness is the main thing here. Let's just bear this in mind. Q3 cuts. I mean, that's a little ambitious. People are talking about November, December, not Q3. Yeah, Q3 is looking a little ambitious, but look, I'll stick with it. I would be minded to push it out rather than pull it forward, but I don't believe in changing your bets if there's something as important as a pint of beer riding on it. So I will stick with third quarter, but it's a conviction weekly held, put it that way. I will not be buying you a pint until at least Q4 of this year, just in all fairness, in all fairness.

11:05Okay. Okay. I look forward to it. It's going to be delicious. All right. Sounds good. We'll be back in a moment with Long Short.

11:15Welcome back. This is Long Short, that part of the show where we go long, a thing we love, and short a thing we hate katie what are you long or short i am long whoever is doing the pr for liz truss oh my god she's so cool i really i love her i love her man you will remember liz truss as the woman who was prime minister of the uk for 40 something days and she set fire to the uk government bond market in the process she's now on a kind of comeback tour uh she's got a book and she's everywhere you cannot move for like news pieces and podcasts and televised stuff about Liz Truss telling everyone that she was right all along and that she was thwarted by dark forces.

12:00She has opinions on everything such as the dollar's reserve currency status, which we all saw what happened to Sterling when she was in charge. So that is an interesting one. And why she should have sacked Andrew Bailey, governor of Bank of England, which again is interesting because you could very credibly argue that he really got her out of a hole at quite a bad time. So yeah, I just, for sheer exposure levels, hats off, job well done. I know I said this last time we talked about Liz Truss, but the name of her book, 10 Years to Save the West, is like a truly hilarious title because it's like, oh, it's actually not that urgent then.

12:38We can kind of put it off to year five or year six, like, oh, whatever. Yeah. 10 years is a long time if you've only been prime minister for 44 days. Exactly. That's like a lot of prime ministers you can cram into 10 years. Oh, Liz. Again, I said it last time, come on the podcast. We'd love to have you. Katie, I don't know if I'm exactly long or short this, but our columnist, Patty Waldmere, had a great piece in the FT recently about Cicada Geddon, the onslaught of cicadas coming to the Midwest United States. And, you know, we've seen cicada waves before they happened. But this year, we are getting two waves overlapping for the first time in over two centuries.

13:17Patty has an excellent quote in her piece in the FT. It will be like having a National Geographic special in your backyard. People will see birth, death, and wild sex in the treetops. Apparently, they pee a lot as well. I also read in that column. I learned a lot about these little critters. I did too. I'm sure of it as well, though. There's just too many creepy crawlies. It's not nice. Yeah, like the photo that Patty had in her article kind of unnerved me. And one of the people that she quotes in this piece is somebody who's doing exposure therapy in preparation for the cicada onslaught. Heavens, no, no, no.

13:55It's a no from me. I guess I'm short. Alright, Katie, it's good to have you here. We'll have you back soon. Listeners, we're back in your feed on Thursday with another episode of Unhedged. And we'll catch you then. Unhedged is produced by Jake Harper and edited by Brian Erstat. Our executive producer is Jacob Goldstein. We had additional help from Topher Forhez. Cheryl Brumley is the FT's global head of audience. 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.

14:31Just go to ft.com slash unhedged offer. I'm Ethan Wu. Thanks for listening.

14:48We'll be right back.