News alert: Fed acts normal

0:00This episode is brought to you by BigData.com. Your AI is only as smart as its data. BigData.com connects Claude, ChatGPT, and Copilot to the sources hedge funds and asset managers use. SEC filings, financial times, earnings calls, and over 2.5 million transcripts from 50-plus countries. Verified, institutional-grade intelligence right where you work. Try it free. Pay-as-you-go plans start today at BigData.com. Finally, something normal has happened. It really feels like it's been a while. US inflation is too high and the Federal Reserve has done the normal thing that normal central banks do when inflation is too high and raised interest rates for you.

0:44It's the first move like this from the Fed in three years. Now, in fairness, this is something my co-pilot Rob has always said would happen and I expect him to remind us of that roughly four million times during this podcast. Donald Trump obviously is pissed off and he's saying the usual stuff about how rates should be much lower but it really feels like we are learning to ignore him. So today on the show it turns out the Fed does have the guts to raise interest rates just before the midterm elections after all. Thank Fed for that. Are we heading for a period of sanity? This is Unhedged, the markets and finance podcast from the Financial Times.

1:27I'm Katie Martin, a markets columnist locked in an underground lair at FT Towers in London. Joining me down the line from New York City is non-robot human, Mr. Robert Armstrong. Rob, this is nice, isn't it? Talking about normal things like normal people.

1:44Katie Martin: It is a big relief. And I think relief is the appropriate response. But as you already pointed out, the appropriate response from me is shouting about how right I was all along. Yeah. That is reference number one of four million. Yeah. Only three million nine hundred and ninety nine thousand more references to how right I was to come in the show. Yeah, exactly. Now, normally, I would say a high inflation, rise in interest rates. This sort of doesn't rise to the level of being something we need to do a podcast about it. This is just how the world works. But these are obviously extraordinary times.

2:25So what actually happened?

2:28Katie Martin: The Federal Reserve Open Market Committee decided to raise interest rates by a quarter of a percentage point for the first time in several years. And just as importantly, the committee voted unanimously to do so, which wasn't at all clear they were going to do going into the meeting. No, I think people were expecting some sort of split there, right? But no, they were like, we move as a pack on this. We all agree a quarter point rate rise is the right thing to do. But beyond just the absolute basics, there's a lot of like nitty gritty that markets people like to sort of unpack around what the Fed does and says.

3:08There's two main things that I think were important to people here is this thing called the dot plot and then also communication. Like what did Kevin Walsh say and what did he indicate about what's happening next?

3:21Katie Martin: Well, on the dot plot, which just to remind listeners, is this graphic that the Fed puts out sort of every other meeting, which shows for each member of the Monetary Policy Committee what they think the appropriate policy rate is going to be at the end of this year and for several years to come. Kevin Warsh, I will flag right here, objects to the existence of this thing and does not participate in it. He's not playing. But the rest of the committee is participating. And their dots showed that another rate increase was coming this year. And they showed some general firmness of mind about the years to come.

4:02Katie Martin: So this was not only an increase, it was a hawkish increase. Yes, so what they could have done is said, OK, we're going to raise rates this one time, but then we probably won't do any more after that. And that is not what they've done. They've said, no, we're on a mission here. We are going to bring this inflation down. Kevin Warsh's view is you should never say anything about your next move. And he didn't. But he was quite affirmative that everyone concluded that they needed to raise rates this time. And he said, you know, the economy looks strong. We're not worried about employment. Once again, inflation is simply too high.

4:45Katie Martin: He sort of said this was an easy decision, which sent that message that implicitly we might not be done here. I was going to ask, because this is the whole thing with Kevin Walsh and his communication style, is that he's been quite insistent that he doesn't like forward guidance. He doesn't like spoon feeding the markets and telling them what is coming next. And so he has said, I'm not playing your stupid dots game. I'm not playing pin the tail on the donkey. I'm not putting a dot on this. What's it called? It's the economic projections dooday. Yes. Statement of economic projections. That's it.

5:21Katie Martin: The SEP. And I think he would like to get rid of the whole thing, which raises the possibility of a nice irony here, which is that in this case, when Kevin Warsh probably would have agreed that it was an important time to send a firm message to the market and possibly to the president as well. The dot plot, which he hates, may have helped him do that. Yeah. Right. So, you know, I think there's a general question here about whether his fulminations against forward guidance actually amount to very much. No, no. It's a good copy, though. Keeps people like me and you busy. So the rule of thumb with the Fed and really with most sort of developed market central banks is that they don't mind surprising the market with a cut where it's like, so something bad has happened, some sort of recessionary shock has come from somewhere.

6:15and the central bank can arrive on like a white horse and say, don't worry, everybody, I'm going to save you. Here's an interest rate. Yes. They don't like doing surprises the other way around. So they don't like surprising the market with a rate rise. And so Kevin Walsh, a few weeks ago at the central bank symposium in Jackson Hole, he had sort of laid the turf for this to happen, right? He had said inflation is a problem. The way that you deal with inflation is with interest rates. And so, you know, you can see where I'm going with this kind of thing. So there was a kind of sense in the markets earlier this week that he'd like painted himself into a corner because there was a punchy inflation reading after Jackson Hole.

6:57So suddenly it becomes impossible for him to like not do this thing. So do you feel like he'd sort of made his own bed and had to lie in it to some extent?

7:08Katie Martin: I think there is an element of truth to that. I do think, by the way, the hike made sense just on the economics. So I'm not worried about it. He did something that he shouldn't have otherwise done. Yeah. But it is an interesting question as we try to get to know this guy, how he handles himself. And he was very hawkish in Jackson Hole. And the effect that had is it made everybody in the market say, holy crow, there's only one inflation data point or one big data point left before we go into the next meeting. It's the August CPI number. The August CPI number decides everything. And he was kind of pushed on this point.

7:53Katie Martin: Like, was the August CPI number decisive? And he was kind of like, no, certainly not. We look at long term trends and very sophisticated things that are full of economic models that, you know, I don't have time to explain right here, et cetera, et cetera. And I think the response from the world is so what you're saying is, yes, it did all come down to the CPI number. I mean, CPI is not the Fed's preferred measure of inflation. But even if you look at PCE inflation, core PCE, correct me if I'm wrong, Rob, is like a 3.7 percent. And the target is two. So the case for like not raising rates is like kind of whack, isn't it?

8:35Like you've got to stick to your own rules.

8:37Katie Martin: So PCE and CPI are importantly different, despite the fact that they're based on a lot of the same data underneath the hood. CPI, the consumer price index, is weighted differently than the personal consumption expenditures price index. And while the two are related, and you can look at what's happening in CPI, which comes out first, and then have a pretty good prediction for what's going on with PCE, they have come apart significantly now. And it's very important, and Warsh has spent the last couple of meetings emphasizing this, for the world to know which one is the Fed's target. And the target is PCE and the number they want is 2.0%.

9:20Katie Martin: And we're at three point something and that won't do. And that simply won't do. Now, the way that the market has read this decision from the Fed is, first of all, just few, right? Because there were some moments in the hours running up to the decision where the US government bond market, look, it was tiny flickers. But they were flickers that are saying, hang on, he is actually going to do this, isn't he? There were flickers. They were scary. They were quite scary. And people were calling me and saying, I'm betting against. You know, the market was at like 90%. Yeah. There's going to be a rate hike.

9:53Katie Martin: And people were excited to bet against that. Yeah. Up till the last minute. The thing with that is that, so if you think you're going to get a rise in benchmark interest rates, then that means that bond yields are generally higher. And as we've discussed before, they are incredibly high at the moment. And that means there's lots and lots of sellers out there of US government bonds. But when I was talking to people in the RAPSIS decision, they were saying, it's just not clear to me there's anybody left to sell these damn things. Like everybody. Everybody's full up. Everybody hates these bonds. People are already pretty much maxed short on these things.

10:29They are pretty convinced that we're going to get this rise in rates. But nonetheless, the takeaway that we've had is this is I think Rabobank were calling it. This is a declaration of independence from the Fed. They are saying, we understand the president's position very, very well on this, but sorry, we are in charge of this, not you.

10:49Katie Martin: Yes, not you. And that is important, isn't it? Because this has been a big question for a long time. You could frame this whole meeting as being not about short-term interest rates, which is what the Fed controls, but about the 10-year Treasury yield, which is the long end and which scares the crap out of everybody lately. And it rose a little bit after the meeting, as you might have expected when they're a bit hawkish. But as of right now, we are back below 5%, 4.949, it says here on my screen, and falling. And I think the initial reaction was the Fed is going to raise rates a little more than we expected.

11:31Katie Martin: And that will have an upward effect on yields. But now perhaps what you're seeing is people saying, OK, our worries about Fed independence are really and truly behind us. These guys are serious relief. Declaration of independence, as you say. So this is an outcome that not only Warsh will be very pleased to see, that is 4.95 versus 5 plus, but Scott Besant will be very glad to see. And if he's sensible, which he is not, the president will be glad to see it. Yeah. So it is an interesting point, isn't it? There's been a lot of ink spilled on this among analysts and investors recently. When you look at the big rise that we've had in US government bond yields over the past few months, so rising borrowing costs, falling prices on these bonds, people have been really scratching their heads trying to figure out why are these bonds weakening?

12:29Is it the inflation? Is it the extra spending that comes from the government? Is it something about the credibility of the Federal Reserve? And the answer is, yes, it's all of those things. But I guess this small decline that you've seen in the yield since this decision from the Fed is like, that's the portion of this rise in yields that has been down to this big question mark over whether Walsh is just going to do whatever Trump tells him to.

12:57Katie Martin: And there wasn't that much risk in the price, I would say, but there might have been some. And you're right. We may be seeing that dissipate. Yeah. I should mention that Warsh was asked specifically about the 10-year yield. Oh, was he? And he said, look, that's the most important price in the world, the 10-year yield. And he gave three reasons for why he thinks it was getting higher. He listed economic strength. He said competition for capital. And he mentioned the hyperscaler debt that's out there and geopolitics, meaning, you know, hotspots around the world. You know, you're talking about oil, but he mentioned other commodities as well.

13:37Katie Martin: He didn't mention fiscal spending, which I think he believes. I think if he was speaking his inner truth, he would have said it would sure help if those dicks in Congress would cool it once in a while. you know what i mean but arguably it's not his job to say that so he didn't say it no you know how you want to weight the ones he did mention economic strength i think that's a contributor uh competition for capital i think you and i kind of disagree about this a little bit i don't think it's a big factor you think it's a slightly bigger one and geopolitics it's the oil price I agree, oil matters.

14:21Well, I mean, speaking of oil, so Trump was asked by a reporter after the decision, do you acknowledge they're raising rates to bring down prices because of the war in Iran? To which he said, no, they're doing it to make Trump look as bad as possible. The problem is we have the greatest economy in history. So he also said, and I raise this mostly for comedy value. He said on Truth Social, I think, interest rates in the United States should be 1 % or less, okay, because we are the best credit in the world by far. And he said, I told Kevin, presumably Kevin Walsh, you may as well vote with the board because it's just not going to matter.

15:04The board is very hostile. So he talked about how, you know, all these other pesky people, you know, making this decision over interest rates, they're all political animals, they're out to get me, yada, yada.

15:15Katie Martin: But Warsh is my guy. And if he was really free, he would have voted my way. Yeah. But what I find interesting is like a few months ago, this was like such a big deal. Whenever Trump said anything about interest rates, it was like, oh, my God, we're all going to hell in a handcart. He's interfering in monetary policy. And now the market reaction is like, go and pound sand. Like it's old man shouts at cloud like whatever. Yeah. A hundred percent. He tried it on with Powell and he failed. That's the relevant point here. Like he got punched repeatedly directly in the face. Right? Like it didn't work.

15:54Katie Martin: And now, first of all, it's his guy. Yeah. Second of all, he tried it before it didn't work. Third of all, he's out the door in two years and everybody knows it. The guy's a wasting asset. Right? So it's like shout whatever you want over the sound of the helicopter you're getting onto. No one cares. Yeah. So I guess one question I have after all of this excitement with the Fed is do you feel like we've seen the top in yields now, in bond yields? Like has this sort of horror show finished? Well, I think we can go back to Warsh's laundry list and then supplement it, right? Is the U.S. economy going to keep re-accelerating?

16:39Katie Martin: A lot of that depends on the AI boom. But if the AI boom keeps burning hot, maybe it does. Competition for capital, again, comes down to how many more corporate bonds are we going to see offered by these huge companies. Geopolitics, do you think the war is going to end soon? So we're saying no. Do you think Congress is going to wake up tomorrow morning and find that fiscal probity is the thing they wanted to perform all along? No. So when I look down that list, I don't see any reason this has to be the top. It could be. But all the forces that have pushed 10-year yields as far as they have come up to the line of five, those forces are still in play.

17:25Katie Martin: Yeah. I guess the only thing that's pulling in the other direction is positioning, right? It is the fact that everybody who hates U.S. government bonds is already short U.S. government bonds. So who's the marginal seller? Like who is out there that is still able to kind of move the dial and sell these things and move borrowing costs higher? And we should mention with the Fed joining the other global central banks, we have a global tightening of monetary policy, Japan, Europe, the U.S., right? And although pushing up short-term rates kind of mathematically puts upward pressure on long-term rates, higher short-term rates should cool the economy at the margin, and that brings long-term rates down.

18:10Katie Martin: So that is a countervailing force to higher yields over the long run. I guess that's true. But the main thing is, hooray for normal things happening, like normal people. Hooray! I love it. I'm here for it. Okay, we are going to have to come back in just one second with Long Short.

18:52countries. Institutional grade data right inside the tools you use every day. Start your free trial at bigdata.com. Alrighty, it is time for long, short, that part of the show where we go long, a thing we love or short, a thing we hate. Rob, what you saying?

19:10Katie Martin: I am long more in regret than enthusiasm. The humble potato. There was an extremely sad story in our newspaper today that because of the heat wave in Europe, 3.1 million tons of potatoes were wiped out. And, you know, I'll just have you know, in an average winter, that's almost half the amount of potatoes that I eat. And I'm going to miss those potatoes. Yeah. One of my very favorite foods. And look, if this attack on the potato doesn't get people focused on global warming, I don't know what will. You know, you can do a lot of things, but you take our chips away, as you would say over there. Yeah.

19:56Katie Martin: You know, it's time to fight to the barricades. Wasn't there a glut of potatoes last year? So I guess swings and roundabouts. But yeah, I mean, this summer, it's just been too hot. We want gluts of potatoes. We can't have enough potatoes in the Armstrong household. We want them plentiful and cheap and fried. Yes, please. In that order. I am long. I'm sure you've seen it, Rob. the story about the Russian guy who funded part of Donald Trump Jr.'s wedding celebrations. The ProPublica story. It's perfect. I mean, our lawyers will be delighted to hear. I don't intend to go through the details of it.

20:31But somehow, when you read it, it's like every line is like more jaw-dropping than the last. And you're just reading it and you're like, what the hell is going on here? Like, it's just extraordinary. I mean, if you haven't read this story, get yourself online and read it. It's a duel. It is a proper duel. So listeners, we will be back in your ears on Tuesday. Make sure you listen up then and we'll be back.