The Fed’s silent treatment

0:08Rob Armstrong: It looks like the US war with Iran is back on. The US is dropping bombs on Iranian infrastructure and Iran has been firing on commercial shipping in the Strait of Hormuz. Here we go again. Donald Trump has declared that as far as he's concerned, the ceasefire is over. Now markets are a bit spooked. Oil is up about$80 a barrel. It's not like March. But the question is, is this enough to push inflation up and force the new chair of the Federal Reserve, Kevin Walsh, to raise interest rates after all? Today on the show, it's war and Walsh. This is Unhedged, the markets and finance podcast from the Financial Times.

0:53Rob Armstrong: I'm Pushkin. I'm Katie Martin, a markets columnist at the FT in London. Joining me down the line from Brooklyn, New York, is Rob Armstrong off of the Unhedged newsletter. Rob, who are you supporting in the football now that the US is out?

1:09Katie Martin: The Britain soccer cats out of allegiance to you, Katie. I have a lot of friends over there. And because of that, I'm rooting. I'm hoping that it comes home briefly before it goes back to France.

1:24Rob Armstrong: okay good thanks thank you for your service so um god war again really why what's going on

1:34Katie Martin: well i think you know we now have learned that trump announcing that the ceasefire is over tells you that the ceasefire is over right now on thursday at 9 46 a.m eastern time but it doesn't tell you very much about whether the ceasefire will be over on Friday. Even saying that, the fact that missiles are being shot and shipping is being disrupted has to change your calculus of the situation, even acknowledging that it could all be different tomorrow. So it matters. And look, oil is telling you that it matters some. You know, we had a whatever 5 % raise, a 5 % increase in the price of rent yesterday.

2:18Katie Martin: And that shows you that despite the vicissitudes of this conflict, you have to take it seriously when the missiles start to fly again.

2:25Rob Armstrong: Yeah. I mean, cynics were saying right from the start that the ceasefire wasn't worth the paper it was written on, if indeed it was ever written on any paper in the first place. So it's not a huge surprise. But so there's a few interesting things going on here. As you say, oil is back up about$80 a barrel. It was getting close to about$70. So, you know, we've had a decent move higher. And one of the things that happened earlier this week was when this all kicked off again is that government bonds took a knock again. Because as listeners to this show well know, when you get higher oil prices, all things equal, you get higher inflation.

3:02Rob Armstrong: Bonds really don't like inflation. So that pushes the price down and it pushes the yield up and it pushes borrowing costs up for everybody and is generally bad. And we've had another flicker of that over the past few days. And that kind of collides with another big market event that we've had this week, which is the minutes from the first meeting of the Federal Reserve under the new chair, Kevin Walsh. And we'll come on to the details of that in a minute. But what investors are saying, to me at least is okay we understand that kevin walsh wants to say less like arguably we should

3:38Katie Martin: all say less you and i should possibly shut up but kevin people have been saying this to me for

3:43Rob Armstrong: some years now katie well one of the things people say to me about why they like this show is that it's short which is make that what you will the food's lousy but at least the portions are small so Kevin Walsh likes saying less all all all power to his elbow but one of the things that means is that investors kind of don't know how to read him and they don't know how to read the Fed and they don't know whether this kind of pop higher in oil prices means they need to think again about what they think the Federal Reserve is going to do next whether it needs to raise interest rates. So we're just sort of in this sort of soup of confusion and trying to double guess what the Fed does.

4:28Katie Martin: Well, take a step back, because I believe, and I think a lot of people believe, that for Kevin Warsh, the confusion and the volatility is somewhat the point. I think of his, or one part of his kind of philosophy of, you know, finance and economics over the last 15 years is that it has been anesthetized by a Fed that is too activist and a government that spends too much money. And there needs to be kind of more free market, free for all, laissez faire, what have you, especially in financial markets. So I think part of the reason he wants the Fed to be all oracular and not say very much, it's like a little bit more volatility and a little bit more you guys figuring out yourself injects caution into markets, might make them more stable over the long run.

5:25Katie Martin: You get some short-term volatility, but people pull their risk in a little bit, all of this good stuff. So I think Kevin Warsh would listen to you saying, I'm talking to bond traders. They don't know what the hell's going on. I think in his heart of hearts, he's probably listening to that and saying, good. That's the point.

5:41Rob Armstrong: Yeah. Look, it's not the job of the Fed to hold the hand of people who trade government bonds for living and you know i i totally get that all i'm doing is like observing that i do think this is like the first taste that we've had under the new wash fed of outbreaks of volatility that are possibly slightly larger than they necessarily need to be because of this uncertainty over what this means about how the fed thinks about the world so we had minutes from the fed earlier this week didn't we this was the the first rate setting meeting under kevin wash's chairmanship They kept rates on hold. But what did they say?

6:19Rob Armstrong: Did we learn anything more about how he intends to operate?

6:23Katie Martin: Let me just first say I was slightly worried going in that there would be no minutes at all and I'd have nothing to write about. But so we got we got some minutes. Louis Ashworth over at Alphaville wrote a good post about how it was quite a bit shorter than your average set of Fed minutes, but it wasn't a haiku or anything like that. And what I would say about that is we had a mystery after that meeting back in June. And the mystery was, why don't you just raise rates? Wor sits there and he says, inflation has been too high for too long. And the reason it's been too high for too long is because of bad monetary policy.

7:07Katie Martin: I am the new monetary policy boss. We're going to get this right. Right. And so the question is, if inflation is too high and the problem is monetary policy, don't you want to change monetary policy?

7:19Rob Armstrong: Maybe radical. Yeah.

7:21Katie Martin: You know, so why didn't he say, OK, and we're going to start the bidding with a quarter point increase in interest rates. The minutes overall were pretty anodyne, but they were sprinkled with these comments that were like, yeah, you know, maybe the risk of inflation is more to the upside here. Some members of the committee made the case for higher rates. The level of uncertainty is high with the war in the Middle East and with tariffs and with everything else. And so, if anything, it deepened my question about why aren't we doing rates now? And maybe it made me think we're more likely than before I read them to get a rate increase at the next one or two meetings.

8:01Rob Armstrong: We've chatted about this on the show before, haven't we? Like Kevin Walsh has been very clear about this. He doesn't want to give what we call in finance circles forward guidance. So he doesn't want to give clues about what the Fed is going to do next. Fine. I can get behind that. But as you say, the contradiction that's embedded in that is that he won't explain why he's not responding to higher inflation today with higher rates. We definitely have a set of circumstances and a set of economic data that a different Fed could choose to raise rates into this.

8:32Katie Martin: Yes.

8:32Rob Armstrong: And that wouldn't be crazy. It wouldn't be a mad thing to do.

8:35Katie Martin: Two theories for why Warsh and the committee, and it's important to bear in mind that this is a committee decision, why Warsh and the committee didn't raise rates this time. One, they thought a little tough talk and the market will do it for us. Right. You know, we say new sheriff in town and we puff out our chests a little bit and financial conditions tighten. And, you know, maybe, you know, like you said, you spook bond yields up a little bit. Maybe you calm some of the exuberance in the stock market, et cetera. And the market effectively does monetary policy for you. And we saw some of that, right?

9:14Katie Martin: We saw some very mild tightening of financial conditions after the Fed's meeting. Second theory is they think this inflation is, wait for it, transitory. In other words.

9:25Rob Armstrong: The T word.

9:26Katie Martin: Now, they will never use that word. but yeah some people on the committee i'm paraphrasing but some people on the committee think as tariffs fade energy prices return to normal etc etc you know a lot of the inflation will keep coming out of the system housing inflation is coming down a little bit too so the other theory is they're sitting there saying maybe if we just sit here in our very quiet mean old inflation will go away you know yeah and maybe we are just small beans we are

9:57Rob Armstrong: small beans maybe the inflation will go away but so for for listeners who missed this whole thing last time we should just sort of explain why that t word transitory why it is so radioactive in markets and the reason for that is that when inflation absolutely rocketed after covid so the whole the economy all shut down everything was terrible the economy all opened up again and suddenly there were all these like supply issues all over the place. You couldn't get your hands on stuff. So the price for stuff went through the roof. Inflation went completely crazy. And for a long time, big sensible central banks said, don't worry about this, everybody.

10:37Rob Armstrong: It's just going to be transitory. Like it's just going to pass. Now, you can argue about what the word transitory actually means. And in the final analysis, I think they were right. It was transitory and it did go away. But the perception, certainly from people like Kevin Walsh at the time, was, for the love of God, guys, why aren't you raising rates? Inflation has gone crazy. You're too late.

11:00Katie Martin: Yeah. And I think, for me, it was pretty clear that they did raise too late. At some point, when inflation starts to be running at 6%, 7%, the argument about where it comes from and what inflation really is and how many angels can dance on the head of a pin has to end. And the Fed's job is just to scare everybody a little bit and, you know, get inflation to simmer down. But there is a perfectly respectable point of view that says we're not at 6 % now. We're at 3%. We've been at 3%. It may be increasing a little bit, but not by much. and these price issues are not generalized, self-reinforcing inflation endemic to the economy.

11:51Katie Martin: They're sort of situation specific. So the argument is not totally bonkers. It just has a bad history in the last couple of years. Yeah.

12:00Rob Armstrong: Well, one other thing that I've been chatting to a few bond fund managers about in the past few days is they're really unnerved by this thing that Kevin Walsh is doing, which is saying, you know, there's a bunch of different inflation measures. And my favourite one happens to be this one, right, the trimmed mean or whatever. So you can get CPI inflation, but you can also get PCE inflation, you can get core PCE inflation, you can slice and dice how you measure inflation a million different ways. And we've all sort of settled on one and the Fed's preferred one has always been PCE. But he's coming along and saying,

12:40Katie Martin: well, I actually, I kind of like this one, which just happens to be the lowest out of the bunch

12:46Rob Armstrong: of them. And some bond fund managers are saying, this is kind of cheating though, isn't it? Because if you look at the others, it does say that you should be raising rates, which is the last thing Donald Trump wants. So did he say anything about these or did that come up in the minutes?

13:00Katie Martin: That didn't come up. I think we should unpack what trimmed means. I think it's a very important concept in the conversation we're having right now. So, you know, when you measure inflation, you like do this almost impossible job of seeing what all the different prices in the economy are doing. Eggs, gas, paint, houses, rent, whatever. And you take them all and they're all over the place. And you try to figure out from this swarming mass of different prices, what the central trend is. And the trimmed mean approach just says, let's cut off the biggest price changes at the top and end of the spectrum, because those are just kind of outliers.

13:39Katie Martin: Let's look past those. And that's related to that thing I said before about the difference between inflation that is kind of endemic to the heart of the economy and is self-reinforcing and has to be out and inflation that's a couple of weird things happening that will probably stop happening. Right? You know what I mean? And the question for the central bank at a time of inflation is always, which of those are you in? The coincidental, transitory, incidental kind or the endemic kind? And if you look, and I think what Warsh is inclined to say is you look at trim mean and you're not in the endemic kind.

14:21Katie Martin: Things are maybe getting a little better. He talked about this at his confirmation hearings. So is that cheating? Kind of. You start throwing out prices because they look like they're moving too much. You don't like this one or you don't. We all do this as analysts. You know, the data comes in that we don't like and we're like, yeah, that one doesn't count. That's a tricky road to be on. So when I say it's kind of cheating, I really want to emphasize that kind of. It's something we all do as analysts but you have to be damn careful about which pieces of data you

14:52Rob Armstrong: decide to ignore right as an analyst but either way what we've got after this apparent like re-ignition of the war in iran is that markets think that interest rates are going to rise after all quite a lot sooner than they previously did so um there's a quarter point rate rise now priced in for the Bank of England by the end of the year. That had not previously been expected until midway through next year. There's a quarter point rise from the Federal Reserve expected by October, which is a bit earlier than previously expected, and from the European Central Bank by September, which again is earlier than previously expected.

15:30Rob Armstrong: So, okay, so stock markets are not like completely going nuts at this war being back on, you know, question mark. But they are saying, look, this does have a meaningful impact, actually, on what central banks are going to do next. And we think this is going to be global.

15:48Katie Martin: Correct. I should say something about this that makes the Fed's position slightly more comfortable in terms of not having to raise rates. I wrote about this yesterday, is that the job market is still a bit squishy in the United States. You know, we had written about how the recent job additions numbers last three or four months have been pretty good. And, you know, friend of the newsletter, James Athie of Marlboro Group wrote in to note, yeah, but you look at every other job market indicator and they are all saying the job market is pretty stagnant. And he's quite right. The thing about the endemic kind of inflation is that generally happens with a hot jobs market alongside it.

16:40Katie Martin: And I don't think there's a very good case that the job market is hot. You might argue that the job market is fine. In fact, that's what I would argue. But it's very hard to argue that it's like tight and hot and kind of inflationary feeling. Yeah.

16:55Rob Armstrong: But all in all, I'm going to say a Fed that's trying to say less rather than more, that's trying to be data dependent without being all over the place. When you mix in quite a volatile news event like a war, you definitely have a recipe for some potentially ugly moves in markets. And one thing I would add to that is it is summer. And I know it sounds ridiculous, but in summer, people go on holiday. There's a lot less trading that happens. There's a lot less liquidity in markets. And so sometimes you just get like really violent market blow ups for close to no reason at all. And I really would not be surprised to see that happen in the next few days and weeks.

17:41Rob Armstrong: because, again, an unpredictable situation like a war, an unpredictable Fed, and sort of skimpy, flighty markets equals bad, I'm going to say.

17:53Katie Martin: I think that could be true. You clearly have an irrational fear of the summer. I have an irrational fear of the month of September. I always feel like nobody really wants to have a crisis during the summer until vacation is over. So it's like, let's mark our calendars and have the crisis in September. when we're all back at work.

18:13Rob Armstrong: Let's remember to freak out in September. Yeah. Yeah.

18:18Katie Martin: Well, none of this probably bears much scrutiny, you know, if you really studied the history, but you can be scared of August. I'll be scared of September and we'll talk about it in October.

18:27Rob Armstrong: This sounds like a fair deal. Which month are you more scared of? Listeners on hedge.ft.com. One next thing to be scared of is long short and we're going to be back for that in one sec.

18:44Rob Armstrong: Okie doke, 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 are you saying?

18:53Katie Martin: I have to be Long the Duck, Katie.

18:56Rob Armstrong: The Duck?

18:57Katie Martin: The Mighty Duck. And I'm not talking about the sports team, the Mighty Ducks. I'm talking about the following brilliant opening par of an FT story. A dispute over the meat used to make Peking duck could ignite a trade war between the EU and China after Brussels on Thursday opened an investigation into dumping of Chinese duck meat at below market prices. Wait till they find out about the sesame noodles, Katie. Yeah. Trade war is on the way and it's all about Chinese food.

19:30Rob Armstrong: Only Brussels could get into a diplomatic spat about duck meat.

19:34Katie Martin: What have you got for us, Katie?

19:36Rob Armstrong: Well, I am long novelty election candidates.

19:44Rob Armstrong: One thing that I'm really enjoying about the fact that Nigel Farage's main or maybe in fact only opponent in the by-election that he has called for Clacton for later this summer is someone by the name of Count Binface. One thing I'm really enjoying about that is that I just know that you, Rob, are sitting over there on the other side of the Atlantic reading this stuff and going, what the hell are the Brits doing?

20:09Katie Martin: The guy actually wears this huge bin on his head. I'm worried, is it really hot in there? He must be boiling. Does the bin have like a little fan in the back, I hope? Is he okay?

20:20Rob Armstrong: These are all important questions. He has a policy platform that includes things like cap the cost of croissants at one pound each. And he's had a long standing policy for moving the hand dryer in the men's toilets of his favorite pub in Oxbridge. So, yeah, I'm mostly just enjoying how foreigners are looking on at this and going, I just don't get it. Why is this funny? What is going on here? And how do you translate Count Binface? So the French are apparently calling him Monsieur Tête de Poubelle, which I like. So I'm here for it. And I hope it puzzles you, Rob, throughout.

21:00Katie Martin: It does.

21:01Rob Armstrong: Yeah, good. Mission accomplished. Listeners, we will be back in your ears on Tuesday. So listen up then. Unhedged is produced by Jake Harper and edited by Brian Erstad. Our executive producer is Jacob Goldstein. We had additional help from Topher Forehead. Special thanks to Laura Clarke, Greta Cohn and Natalie Sadler. FT Premium subscribers can get the Unhedged newsletter for free and 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.

21:52We'll be right back.