Warsh and peace

0:00Rob Armstrong: This 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. Sometimes what we all really need is a good dose of nice fresh air. And every year that is exactly what the big dogs of global finance do. All the world's most powerful central bankers head to the beautiful mountains and talk big money in a little place called Jackson Hole.

0:46Rob Armstrong: The latest get-together was at the weekend that just passed and it came at a very delicate time. Investors have been puzzled about what the US central bank is up to, whether it really does want to tackle inflation with higher interest rates or whether there's a little part of it that wants to keep Donald Trump happy by keeping rates low. All that uncertainty has been helping to hurt bond markets. The good news is that Kevin Walsh, the new-ish chair of the Federal Reserve, has calmed some of those nerves with tough talk on inflation. The bad news is that bond markets are still in pain. So today on the show, what did we really learn from Jackson Hole?

1:27Rob Armstrong: And are bonds kind of stuffed either way? This is Unhedged, the markets and finance podcast from the Financial Times. I'm Katie Martin, a columnist at FTHQ in London town. Joining me down the line from New York City is the big guy, Rob Armstrong. Rob, how's it going? You're coming to London soon, aren't you?

1:47Katie Martin: Yes, I am. And we should say that this is very exciting for our listeners because we will be at the FT Weekend Festival this weekend, which is an opportunity for all of you out there, instead of calling the two of us drooling morons in the comments, to come do it in person. So I encourage both our fans and our critics to come see us do our thing in person and then give us a piece of their minds.

2:19Rob Armstrong: Be mean to our faces. Okay, so look, let's rewind a little bit, this whole Jackson Hole thingamy. And investors have had a rocky ride with Kevin Walsh, the new chair of the Fed. Just set the scene a little bit there.

2:37Katie Martin: Okay, Kevin Walsh had two Fed press conferences before his speech in Jackson Hole. And it is my view and the view of a lot of other people that they did not go particularly well. Famously, he withdrew forward guidance. So he said right from the outset, I'm not going to talk about any future Fed actions and what they're likely to be. And this is fine. Philosophically, there are good reasons to be skeptical of forward guidance. However, he wasn't very clear on what was replacing it or what he would be doing or what his other relevant attitudes were. And he said a couple of genuinely spooky things like, well, maybe that 2 % PCE inflation target is something we could discuss changing in the future.

3:26Katie Martin: Yeah. Which is not something that a new Fed chair should say.

3:31Rob Armstrong: Yeah, you don't monkey about with your inflation measures. But he also said, so even before he did his second press conference, the bond market had already been weakening quite a lot. So borrowing costs have been pushing higher. And he was like, that's fine.

3:46Katie Martin: Yes.

3:46Rob Armstrong: You know, I'm fine if bonds are weaker and borrowing costs are higher because there are various benefits that come with that. So the market was like, oh, chief, message received and understood. We're going to keep selling these bonds because that's what you want us to do.

4:00Katie Martin: And again, it's perfectly respectable for a Fed chair to say, look, the long end of the yield curve is going to do what it's going to do. That's not my job. Right. That's a fine thing for him to say. But it's different when you say that and people are already wondering, what exactly is this guy up to in terms of inflation? What is his policy going to look like? So, again, I'm quite sympathetic to Warsh's philosophy so far as we understand it. It's a question about execution, which brings us to Jackson Hole, where I think his execution was a lot crisper. Yeah.

4:38Rob Armstrong: So the market was unnerved by the early press conferences from Kevin Walsh. But then on top of that, the bond market had continued weakening from there. And as we were talking about in the podcast just the other day, the Treasury secretary jumped in and took various actions to try and, quote unquote, stabilize the bond market, which was basically him saying, guys, knock it off. Stop selling these bonds. I don't like these borrowing costs being so high.

5:04Katie Martin: This worked about as well, for the record, as when I tell my son and his friends to be quiet downstairs while I'm trying to sleep.

5:14Rob Armstrong: Yeah, it didn't go super well. So enter stage left or stage right, whatever. Kevin Walsh at Jackson Hole. This is like the big kind of away day for the real grownups in global finance. And it's quite an academic event. People give all of these papers. Like the whole event was under some immensely tedious heading, like the future of payments in an uncertain world or something like very, very dull. So Kevin Walsh came along and everyone was like, right. OK, dude, you've been confusing us. Please stop confusing us. And he kind of did, actually.

5:52Katie Martin: So he was very clear in sending the following message. Number one, the employment side of the economy is quite good. We are at close to full employment, which is about as good as it ever gets. Point number two, inflation is too high and isn't getting better. Point number three, what the Fed does, it does with interest rates. So if you put those three points together, what you're saying to the market is, unless something changes pretty soon, rates are going to go up. Right?

6:31Rob Armstrong: Yeah. He also said, I think the fourth thing that he was super clear about was, I'm not going to muck about with inflation measures and change the one that the Fed is targeting. And I'm not just going to pick my favorite one because there's a million different ways to skin this cat of how you measure inflation. He said that the current inflation measure is, and I quote, a firm, fixed target. So that is a relief.

6:54Katie Martin: That was just so important. Just so important for him to get any confusion completely stored away. That was a really good moment for him. And everybody breathed a sigh of relief there. Let me note a couple of subsidiary points he made, which I thought were very interesting. One of them was that he is not impressed by the slowing wage growth. If you are dovish about interest rates, the standard thing you say is inflation has to come down because the rate of wage growth in the United States has been falling steadily for a couple of years. He was like, nope, this is not a good indicator of future inflation and I'm ignoring it.

7:36Rob Armstrong: Yeah, that's another message that rates are much more likely to drift higher than lower from here.

7:42Katie Martin: And on the employment side, he said something equally interesting. We've talked a lot on this show about the no hire, no fire economy, which is like, yeah, we have a very low unemployment rate of 4.1 percent or something like that. But nobody's getting fired and nobody's getting hired. The job market is stagnant and therefore weak. again Warsh in Jackson Hole nope we had a big shock back with COVID companies and workers are relearning how to match this is not something that impressed me once again quite a hawkish point and so overall the package was quite clear and was emphatically hawkish one thing that I think

8:28Rob Armstrong: is quite funny about all this is that Walsh in that problematic second press conference was talking about look you know the Fed right the central bank it shouldn't be a player in the markets it should be a referee it shouldn't be sort of moving the markets around on its own it should be just sort of an observer to what's going on in the market I mean what we've seen in the markets over the past few days since Walsh made this speech absolutely puts that completely stupid thing to rest because what the markets have done is said okay message received and understood we understand the assignment you are going to raise rates so before he spoke there was about a one in three chance implied through markets that the fed would raise rates in september now it's about a two-thirds chance that's priced in so the market has gone whoosh from one side of the room to the other and saying okay he's serious about inflation he's going to try and bring it down he's quite likely to raise interest rates, whatever Donald Trump thinks about it, because Trump is still being Trump.

9:30Rob Armstrong: He's still calling for lower rates, whatever. But the market is saying we think that he's going to ignore him. Now, the problem then is, like we were saying right at the start, the market for US government bonds has been in a pretty significant amount of trouble recently. But the fact that it now looks like the Fed is going to raise interest rates is making it worse. So it's like, you can't win here. If you say you're not going to raise rates, the market sells off. If you say you are going to raise rates, the market sells off. We can discuss and reasonable people can disagree about why the bond market is weak now.

10:04Rob Armstrong: But what we've seen at the start of this week is that bond prices have fallen really quite a lot and borrowing costs are getting very spicy. So the U.S. 10-year yield is now up at 4.8 percent. And this helps to set borrowing costs for everybody everywhere, whether you're a Brit getting a mortgage or you're a German person getting a commercial loan. A certain amount of that is determined by where U.S. borrowing costs are, and they are a lot higher now.

10:35Katie Martin: So an ideal response to Warsh's speech from the point of view of the Fed and the U.S. Treasury would have been he comes out clear and hawkish. Short-term rates, especially short-term real rates, inflation-adjusted rates come up in anticipation of a more hawkish and active Fed. But at the long end of the curve, rates come down as the market breathes a big old sigh of relief and says inflation is not out of control, is not going to be allowed to get out of control, few. But while we did get the action at the short end, the long end just keeps on climbing, right? Which is not what anybody would have wanted to see.

11:18Katie Martin: And it raises a question. What is going on down there with the 10-year and the 20-year and the 30-year? not only for the United States, but for everyone in the world, basically. Japan, new record today, France, bananas, Europe, whatever. It's everywhere. So what's up?

11:36Rob Armstrong: Yeah, so the Japanese 10-year yield hit 3 % today, first time since 1996, which even old duffers like you and I have to admit is a long time ago now. UK yields are at the highest level since the financial crisis. it's quite hard to sort of articulate this without sounding like an idiot but i'm going to try

11:58Katie Martin: and probably fail but i hope you do sound like an idiot katie speaking for myself

12:04Rob Armstrong: it wouldn't be the first time but like in in markets right markets are supposed to be big serious things that synthesize all possible information at all possible times but in reality things don't matter until they do and when the market decides that something matters and it's going to obsess about it then it matters and it's going to obsess about it whether that is oil prices or private markets or whatever it is and right now the thing that everybody is obsessively worrying about is just governments are borrowing too much damn money and the investors that they're hoping to sell these bonds to are saying I can't buy all this stuff and if you want me to buy all this stuff You're going to have to pay me more to do it.

12:50Rob Armstrong: And so, as you know, it's a phrase I like a lot, but you can't put the shit back in the donkey. And the shit that is currently out of the donkey is the market saying, I am really worried about how much money governments everywhere are borrowing, given that they have completely lost their ability to have honest conversations with voters about paying more tax. So governments are leaning really hard on the bond market, and the bond market is saying, look, we're not just like a cash machine. you're going to have to pay us for this. And I don't know how you really douse that down. I like your point that when something has to happen eventually,

13:26Katie Martin: it doesn't need a reason to happen at some point or another. Right. So you don't have to point to a very convincing catalyst to see why this might be an issue. But let me say there's other theories of what is going on here. There is the Warsh at the head of the most important central bank in the world is screwing things up. That's one theory. I think the fact that he has straightened things out a bit and yields are still rising cuts against that theory a little bit. Another theory is that we really do have an inflation issue here. But market pricing inflation, while it's gone up a little bit, is still kind of in the range it's been for a long time.

14:07Katie Martin: So the inflation story, I mean, it could be that what people are anticipating is inflation volatility, not consistent inflation, blah, blah, blah, you can rabbit hole, rabbit hole. However, the final theory, and a friend of the show, or I should say friend of the newsletter, Matt Klein, in his excellent blog, The Overshoot, made a pretty good case for this this morning, is that it's like, why weren't rates higher already? Because nominal growth in the US and the world is pretty good. You know, final sales to domestic buyers, which is the kind of GDP without all the nonsense, was like 4 %-ish in the last quarterly estimate.

14:48Katie Martin: You put 3 % inflation on top of that, you have 7 % nominal growth running around loose in the United States. How low do you expect the long bond to be under those conditions? You know what I mean? So the growth story is not total nonsense, depending on how you tell it.

15:07Rob Armstrong: The problem is if you jump with both feet into the growth narrative, then another problem you encounter there is that Scott Besant, the U.S. Treasury Secretary, has been very explicit about this. He says the market is wrong and yields are too high and they should be lower. So it's like, God, you guys really need to get your story straight on this one. But the other thing that Besant keeps saying is the market is wrong. the market has bad information. I have good information. So it's kind of, I know something you don't know. I know something that's going to fix this that you don't know. Like, Scott, dude, if you're listening, it's time for you to tell us what it is that you've got up your sleeve.

15:51Katie Martin: Well, today, I think, no, I think it might have been yesterday or today. He said he knows things that we don't know about Japan. He said, I know things about Japanese policy that the market doesn't know.

16:03Rob Armstrong: Did the Japanese know this?

16:07Katie Martin: I mean, he basically said, they're going to do something to prop up the yen, and I know about it, and you don't, I think was the gist of his comments.

16:15Rob Armstrong: I mean, again, time to bust it out, fellas. Like, get this done, because, like, the market is bleeding out here. It's time to, like, get this rabbit out of a hat.

16:25Katie Martin: I should add one more theory, and it's a kind of sub-theory of the growth theory of higher rates, which is sovereign bonds are competing for buyers with the bonds issued by the hyperscalers in massive quantities. And that pushes up the going rate of interest. So that links to the growth theory in kind of a straightforward way, which is what form is a lot of this growth coming in? it's coming in the form of data center construction and AI and nani nani and so you see the mechanism

17:03Rob Armstrong: of action there I have traditionally thought this theory is BS but actually I do think there's something to it you know the governments do have to compete with the big AI bond issuers but one thing I wonder about all this is it strikes me as quite odd stock markets are like looking at this train wreck that's going on in bonds and they're sort of like rubbernecking and saying those people in bonds are having a bad time but like but the stock market is still like just sort of yes sailing higher regardless and that's unusual normally when you have higher borrowing costs that pulls down stocks because suddenly you can get a higher return by buying the bonds so why bother taking the risk of buying stocks and also it means that the borrowing costs and the debt servicing costs for all the companies that are inside the stock market, those costs go up.

17:54Rob Armstrong: So normally it's bad for stock markets when bonds are weak. Please don't bother emailing in with all the sort of nuance around that. I know, but just as a kind of rule of thumb. But so when do you think stock markets get the memo and start puking over this?

18:11Katie Martin: It depends a lot on how much you believe the rates are higher because of growth story. If you are a real believer in that story, If you think growth is going to be great and it's going to be great for a long time, then stocks can go up and bonds can go down perfectly happy at the same time. Because the prospects, even as the real interest rate you get on a sovereign bond gets higher, you'd still rather be in a stock, right? If, on the other hand, you believe the fiscal incontinence story, this does not hold, right? If rates are getting higher because governments can't stop selling debt and can't stop deficit spending, then eventually you're going to have to choose.

19:01Katie Martin: Do I want a bond with a real rate of 3 % or a stock that is meh? And it's going to be a car crash. I agree. So it's not perfectly clear. I know you said no nuance, but I'm afraid I've just given you some nuance.

19:15Rob Armstrong: I just don't want the mansplainers. Yes. I get enough mansplainers in my inbox. I don't need any more. Thank you so much. But listeners, tell us, is it fiscal incontinence? Is it growth a go-go? What is really ailing the bond market? We genuinely don't know. We're interested in your thoughts. So let us know. But we're going to be back in just one sec with Long Short.

19:40Rob Armstrong: A quick word from BigData.com. Your AI tools are only as good as the data behind them. Bigdata.com plugs into Claude, ChatGPT, and CoPilot via MCP, bringing in the sources serious investors trust, SEC filings, Financial Times, earnings calls, and 2.5 million-plus transcripts across 50-plus countries. Institutional-grade data, right inside the tools you use every day. Start your free trial at Bigdata.com. Okie dokie, 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 Armstrong, what are you saying?

20:20Katie Martin: I'm long the public relations industry, which is a weird thing for a journalist to say, because generally PR people, one of their key jobs is driving journalists crazy. But let me say this. I'm writing a piece about the reputation of the AI industry and how it got so bad. and boy oh boy however smart these ai people are man they have made a mess of their pr strategy and so i think even even after the computers take over the world there is going to be a place for that industry and it is needed by these companies because boy they can't do it on their own

21:00Rob Armstrong: no well actually it's funny you should say that because i am also long the data center backlash It is fierce. Yeah. People on, you know, whatever your politics, everyone hates data centers. Yeah, it's remarkable. They eat electricity. They take your job. They take your job. They don't employ that many people. I guess they do in the construction. But just this week, Donald Trump, for it is he, said that Americans opposing the construction of AI data centers want to end up, and I quote, backwards and poor. it's like and one thing that is interesting there right is all this money that these companies have borrowed to build the data centers now they can't get the data centers built because little old ladies in like wherever ohio are like sitting in front of the bulldozers and saying you're not building this thing in my backyard i'm not having it and a lot of that has to do the whole

21:57Katie Martin: communication strategy of the industry has been a disaster. It really has.

22:02Rob Armstrong: They have not

22:03Katie Martin: told their story in a compelling way. Yeah.

22:07Rob Armstrong: Let us build this data center so that we can take your job. No. How about no? Thanks very much. How about no? So listeners, are you too enjoying the data center backlash? I think it's quite entertaining personally. We are going to be back in your ears on Thursday, data centre or no data centre. So listen up then. If you do want to come and be mean to me and Rob at Kenwood House at the FT Weekend Festival, then if you buy a ticket online and you put in the code FTPodcasts, I believe you get some money off.