Rate drop, market drop

0:05Pushkin.

0:10Grateful Dead fam, and also chairman of the Federal Reserve Jerome Powell had a press conference, made an announcement, and the market didn't like it one bit. Stocks fell, bonds rose, the dollar rose. People were not happy. Today on the show, what did the Fed do right or wrong that made markets rumble? This is Unhedged, the markets and finance podcast from the Financial Times in Pushkin. We are coming to you from the Christmas decoration-covered headquarters of Unhedged in beautiful New York City. I'm currently draped in tinsel. We are covered in tinsel. I am wearing an elf outfit and I am joined by my reliable and brilliant Lieutenant Aiden Reiter.

1:02I thought you were going to say helper elf. Helper elf. Exactly. Aiden, what did he say? What happened? So they cut the rate by 25 basis points. Which is exactly what everyone was perfectly certain they were going to do. So that can't be the problem. That's not the problem. Although there are questions about whether or not they should have done that. But we'll come back to that. Okay. What he did was change the manner in which he was speaking about next year. Yes. And then they also put out their summary of economic projections, which is a quarterly thing that comes out with the Fed. Yes. And it showed a meaningful change from the last summary of economic predictions.

1:40Yeah, we should pause there and just give listeners a kind of mental image. So at every Fed meeting, there is a news release which says, here's what we've done with the interest rate. And it also has a lot of verbs and adjectives in there that people parse very carefully. A lot of good writing. And there's always a press conference. And at some meetings, they have this thing known in Wall Street jargon as the SEP, the Statement of Economic Projections. And the SEP has various charts, graphs, and diagrams. It's just like a pocket of charts. And it says, you know, here's what we expect inflation, growth, unemployment, and the policy rate to be this year, next year, the year after that, and in the long term.

2:22And this is the famous dot plots. You might have heard people say dot plots. Essentially, it's just showing you the range of where different Fed members have voted on each number, right? Of where policy ought to be. Where policy ought to be, exactly. So that's the dot plot. So this is very much worried over and fussed over and pictures are compared. And this was notable because it was the first SEP since Trump was elected. Right. The last one is in September. Okay. And what has changed from this SEP is first in September, they said by the end of 2025, we expect there to be a full percent drop in the current policy rate.

2:59Yes. Which would get us into like the threes somewhere. Yeah, low threes. By the end of next year. The low threes. They changed that. They said it's actually only going to be half a percentage point. So 50 basis points. It's a big difference. It's a huge difference. So we're going to be in the high threes. Or even the low fours. Policy, we expect. Now, that's not making policy. They're not saying what's going to actually happen. They're saying what we expect now is somewhat tighter policy. Yeah, tighter policy. That probably by itself would be enough to cause a little tremor in markets. But it was more about how it was delivered, right?

3:33So, of course, every journalist, including our very own Colby Smith, asked the chairman, do people do this because they're concerned about trump's policies why are we changing our projection yes and he gave kind of a wavering answer yes on the one hand he was like no absolutely not but also some people said that they did do it because i think it's worth pausing just to say his exact words here because they're interesting so somebody asks is this because you think trump is going to impose tariffs and tariffs are inflationary or generally trump policy is inflationary And he says, this is not a question that's in front of us right now.

4:12We don't know when we will face that question. What the committee is doing right now is discussing pathways and understanding the ways in which tariffs can drive inflation in the economy. So he says, no, that's not happened. But then a few seconds later, he said something quite different. Some people, this is Jay Poe talking. JP. Some people did take a very preliminary step and start to incorporate highly conditional estimates of economic effects of policy into their forecast at the meeting and said so in the meeting. Some people said they didn't say so and some people didn't say whether they did or not.

4:49And that is the crucial sentence of the whole meeting. He said, some people on the committee who set your national interest rates have looked at the Trump policy set and are changing their projections for what growth, inflation and rate policy are going to be. This is a big deal. And it almost, not quite, but almost contradicts the other thing that he said, which is we don't have to think about this yet. Yeah. It's definitely a big deal in the sense that the Fed is owning up to it. But I don't think it's that big of a deal in the sense that the market has also already owned up to it, right? Expectations for where the Fed would be this year have already kind of changed, right?

5:27If you look at the futures market, it's actually not that far off from what the Fed said they were going to do even before this meeting. We've also seen a change in the stock market in economic projections around the world. Yes. Trying to reflect the fact that Trump might be inflationary. But with all due respect, Aiden, it wasn't all in there. Yes. As we saw from the market slightly throwing its toys out of the pram. Absolutely. As my co-host Katie might phrase it. But it has recovered a little today. It's recovering. We have not, yeah, it has recovered a bit today. But, you know, this did come as something of a shock to markets.

6:00I think we should, you know, context this and remember that we are very far into a long-running bull market. And stocks and indeed all risk assets, corporate bonds, whatever, are all very expensive. And it's probably just worth saying under those conditions, it doesn't take much for the market to wobble. Everybody's made a lot of money. Everybody knows what they own is expensive. They don't need a huge, big, fat excuse to sell a little bit, take some profits and take some risk off the table. And maybe this is just a – this is just foreshadowing what's going to happen a lot next year, right? Every time there's a Trump policy announcement, we don't know what the inflationary impact would be.

6:42We don't know what the impact on the market will be. And the market's just going to wobble a lot. Yes. You know, we wrote a newsletter right after the election called Trump's Fat Tails. And our point was not that he has fat tails, but that we don't know the range of policy outcomes that could result from what he has said and what he actually might do. Yeah. And this is something that I mean, I thought there were potentially the Fed might have made not huge mistakes, but two small mistakes in my view here. The first mistake was I think a lot of people are predicting with too much confidence what the Trump policy set is going to be.

7:16I think Trump says a lot of things. I think that's an uncontroversial claim. Very famously says many things. Says many things. I think his appointments of people into administration posts are extremely mixed. And so those point in all kinds of different directions. And I think, you know, making policies hard. They got a smallish lead in the House. They got a smallish lead in the Senate. They got a weird old world out there they're going to have to deal with. Who knows what's going to happen next year? The things he's actually proposed doing, we've written a couple of times on this, are also just really hard things to pull off, right?

7:54Tariff policy is super vague. We have no idea what every other country will do in response. And that matters to the market. Immigration policy. We have no idea the levels of bureaucracy, federal, you know, red tape and state red tape he's going to have to go through to achieve his immigration goals. And those are the two things the market is thinking are probably most focused on. Yes. Right. So those are not only the most important things, but also the most completely uncertain things. And there's another. I would layer something else on top of that. What is the fiscal policy situation going to be in the next two or three years?

8:28As I have said with immense repetitiveness on this show and elsewhere, I think one really important explanation for the strength of the markets over the last five or 10 years, especially the last five, has been big fiscal deficits. Government pushes money into the economy. It ends up on corporate balance sheet. Stocks goes up. Right. And one thing we really don't know is, is this administration serious about closing the deficit or not? And the tariff and the immigration policy will play that. Then you have Doge, the famous efficiency program playing on that. There's tax cuts playing on that. All of that will figure into the market too.

9:07At this point, there's more variables that I can hold in my head. Yeah. I will say on that point, I think it is fair to say at least in 2025, it's only going to be expansionary for the fiscal policy. He's going to give the tax cuts. Those will happen. Yeah. And it'll take a little time to do. Take a little time, but it'll happen. And Doge, we have no idea. Right? And that's the only thing that would theoretically offset. Yes. So. And they can't snap their fingers. They may be very successful in taking money out of the government. May or may not be. We could have a whole debate. I mean, they won't be.

9:34But it won't be instantaneous. Well, they're actually, they have no power. They're just an advisory panel. So actually, if anything, it's going to be a long, long process. Yes, indeed. So that's mistake number one, I would say. I think that in changing their projections, the Fed has maybe erred on the side of being too confident about, we know it's going to be this, we know it's going to be, you know, it's going to have inflationary impacts. I don't think, I don't even think you can be certain that it's going to be uncertain. I think it's so, uh, and then the second mistake is, did they bring politics into this in an unfortunate way?

10:11Uh, they, you know, they're basically saying this guy looks a little bit inflationary and whenever any of us face the prospect of a new president, we're bringing our own political biases with us. This is where I might disagree with you a little, Rob, in that I think the job of the Fed, more than anything, right, 25 basis points matters a little bit less or a lot less than what the Fed is actually signaling to the economy and signaling to the market about where the economy stands. And it is the role of the Fed to communicate uncertainty or communicate wider bands. So in communicating the fact that, listen, we know that Trump's policies might be uncertain.

10:46Yes, they have upgraded the inflationary forecast. However, they're communicating a wider range of possibilities, especially on Fed rates and where they might be. And that is their job, right? Imagine if they said nothing and then we had another inflationary shock. That would be much worse for households and much worse for the market. So I think they're doing their job. I agree that there's some complicated politics in this, but I think they're still trying to independently assess the trajectory of the United States economy. I think that is a valid counterargument, and I hope you enjoy working for someone else.

11:20I guess we should context this a bit more in terms of the tightening outlook. As you said, the last statement of economic projections was in September. And actually, non-politically speaking, the data has changed. So we got, and I think we've talked about this on the show, the last two inflation reports were kind of no bueno. No bueno. We went from 2.4 in September of headline CPI all the way up to 2.7 in the most recent reading. Same thing, if you even look at annualized, it was like 3.81, it went down, and then went back up to 3.8. Yes. So no matter how you cut the data, the recent trend in inflation, the headline trend at the best looks sideways, at the worst looks up.

12:06It was somewhat expected to have a weird wobbly way down. Yes, of course. But the fact that we have two months in a row going up, and then some of the key things that people are particularly concerned about, like housing, are not completely dead. Yes. I mean, the housing's looking definitely better and shelter and relations better. There's reason that they would have upgraded the projection even without Trump. What is that thing called? I always forget the name of this economic indicator. It's like GDP without the imports and exports and stuff like that. It's like total domestic consumption. Anyway, basically domestic GDP, just how much Americans are investing, consuming spending.

12:43It's going to be up 3 % this year. Like it may not we may not get a 3 % number because of little adjustments for for international activity. But 3 % is way above trend. And what we should note that in the statement of economic projections, they also upgraded their real GDP estimate for next year. Yes. So we have growth that is above trend. We have inflation that refuses to behave itself. I will argue in defense of the Fed, having already said they went a little far on this Trumpy stuff, I will say in their defense, probably tapping the brakes a little bit on next year would have been justified, whatever that.

13:18And the market expected that. Most people expected that. There was actually, you know, the big jumbo cut that we got earlier this year. There was the first dissenting vote in the Fed since 2005. Yes. Saying we don't want to do this. This one also had a dissenting vote. Yes. And not even from a conservative, you know, a more perceived to be conservative, hawkish Fed policymaker. So, yeah, and you can only imagine what the market might have done if they had actually not given a cut at all. Well, let's talk about it then. They're looking forward to next year. Let's spend the last few minutes here, Aidan, talking about what do we think about next year?

13:50What are we kind of expecting for next year? Well, I think, you know, you've said it before, 2025 is not when everything really hits the road. Yes. We're going to be in the early stages of implementing some of these policies. So the policy environment won't change immediately on the 20th of January. it's going to take time. Yeah. I mean, there's a lot of things, non-economic that will change and rhetoric will change and foreign policy that will change very fast. Yes. And that might have flow through the market. Although foreign policy in the market, as we've talked about many times, unclear where it always meets.

14:20All right. But I think at least in terms of the Fed and the Trump administration, we've known Trump to be hostile in the past when the Fed has done things that he hasn't liked. It's well known that he, while did not try to fire Jay Powell, inquired about firing Jay Powell last time. And there's questions of what he's going to do with the Fed appointments he's given in the next couple of years, whether he might put some, you know, fire throwers in there to try to mess with General Com or if he's potentially concerned about. So you are you are you are you are edging towards saying he might push for a Fed that wants easier policy.

14:56Is that what you're suggesting? He certainly wants easier policy, but it's also I mean, you can take it both ways, right? He wants easier policy because in his mind, that is a sign that the US economy is doing well. Inflation is coming down. How wonderful. That being said, also part of this is because the economy is growing so fast and doing so well. So it really just depends on how the media sells it to him and or his advisors sell it to him. I would not be surprised if there is some clashing with Jay Powell and some clashing with the Fed, especially if he hasn't given a cut in the first maybe two, three meetings.

15:27He might make restive noises. Yes. I just think all the worries about Trump and the Fed for me, I mean, we've disagreed about this slightly in the past. I think the new administration is going to be highly cognizant of the fact that inflation getting out of control is what got them elected and got the Democrats fired. So they're going to be cautious. And I also think they, to a certain extent, they will be cautioned by the market. But, you know, if they start to look soft on inflation or they're pushing for an economy that's going to be inflationary, I think the markets are going to tell them, slow down there, cowboys.

16:01But we'll see. Making predictions about this man and this administration, I think, is a big challenge. And there's a history of presidents clashing with Fed chairs. Sometimes it's terrible. Sometimes it's fine. It's fine. Right? So Reagan and Volcker clashed. And, you know, while that was rhetorical and probably hurt the credibility of both the Fed and the president. To like assault his Fed chairman or something? Oh, I have no idea. There's like some story about this. During the Nixon administration, we had a Fed that was probably too aligned with the president and helped stoke inflation. Oh, indeed, indeed.

16:31So you really don't want them to be too aligned, which is why that's my bigger concern. Yeah, yeah. I'm actually okay if they clash. It's just a question of what is he going to do with the appointments he's given? And when Jay Powell's term comes up in 2026, what is he going to do? That is the bigger question to me. Well, on those not particularly Christmassy thoughts, we will be back in a moment with Long and Short.

17:04The weather outside is frightful, the fire is so delightful, and it is time for Long and Short, that part of the show where we go long things we like and short things we don't like. Aidan, are you full of the Christmas spirit? Are you long something? I'm full of the festive, non-denominational holiday spirit. Correct, correct. A nod to everyone celebrating Christmas. I am long holiday wish lists. My siblings and I are all adults now. They all live in California. I don't know what they're doing. I don't know what they want. Indeed. This morning, my youngest sibling sent out, hey, this is what I would like you to get me if you want to follow something.

17:42And I'm very grateful. So I put out my own and I said, you know what? this is fantastic. I'll check it. Let's all be clear. Let's all be clear. I don't need to get you something you won't want. You don't need to get me something that I won't want. We'll just have a nice exchange. In a similar but somewhat contrasting vein, I will go short the holiday gift card. I want to give people a wrapped up gift on Christmas, especially, I mean, sometimes it's nice, like when you're an uncle, just to give your nephew some money. They love that. but there's something about the gift card, the Amazon or the Best Buy or whatever it is, the gift card.

18:19I'm just not into it, man. I think it's unromantic. And the holiday season, as you correctly remind me, it is rather than just the Christmas. You can say Christmas, that's fine. Yes, it's Hanukkah. We're a small minority. I'm actually very okay with people saying Christmas. And, you know, Kwanzaa, some kind of pagan festival, I'm sure. Festivus. All of these festivus, all these things should be romantic. And on that note, I wish all of our listeners an excellent holiday, and we'll be back in your feed next week.

19:12Just go to ft.com slash unhedged offer. I'm Rob Armstrong. Thanks for listening.