Transcript: High interest rate anxiety

This is an audio transcript of the Unhedged podcast episode: ‘High interest rate anxiety’

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Ethan Wu
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 right? 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.

Katie Martin
I will have you know, I received emails telling me I was an idiot. (Laughter) Someone from Kansas . . . And who’s laughing now?

Ethan Wu
I’m sure those emails were from one Robert Armstrong.

Katie Martin
(Laughter) They weren’t. But I keep all of his in a special file.

Ethan Wu
(Laughter) Katie, why was I wrong? Riddle me that. I said Q1 and it wasn’t Q1. What happened?

Katie Martin
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, like the, you know, when that first prediction was made, your bet, which you lost, just to reiterate, which was like June last year, we’re in a whole different environment now. It’s really quite extraordinary how things have turned around.

Ethan Wu
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 signalled the 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. And it just turned out this time was different, right? All those 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 labour market and immigration and all this different stuff that kept the economy going so strong.

Katie Martin
Yeah. You know, 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 and everyone said, eh 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 forecasts for rate cuts from the Fed for this year and markets don’t like it and everyone’s in a tizzy.

Ethan Wu
Yeah, 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, it feeds right into the GDP data. Other activity data has been good. Industrial production, manufacturing are both picking up. We get month after month after month of like solid, solid, solid employment data.

Katie Martin
I mean, how does the Fed cut into this? 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, yeah, 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 US consumer and we get this kind of punchy US 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 US economy is just too strong. The Fed just might not be able to do this.

Ethan Wu
Yeah. I wanna 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. 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. You know, CEO of McDonald’s who should have a good sense of, you know, how US consumers are feeling, is saying stuff like “This is a challenging consumer environment” and 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 sort of start to eat away at activity over time. That’s the bear case, right, that there’s weakness on the periphery and over time, it’s 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 per cent GDP forecasted for the second quarter right now. 2.8 is too high. That’s not gonna last. It’s gonna come down.

Katie Martin
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. You 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. (Ethan laughs) 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. Who knows what is a blip? You don’t know that you’re in a blip until it’s in plain sight. 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 squirrelled 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 without a recession, there was this idea that they were gonna cut that hard, which felt too much to me even at the time. Now the market is saying, eh, we’ll get one, maybe we’ll get two if we’re lucky. And that, I don’t know, that just changes the game.

Ethan Wu
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’ve recorded our first episode of this podcast, which is how I delineate all time in like my mind. (Katie laughs) 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 into like March of this year it’s been like Nvidia, AI, growth, rate cuts. It was truly like the market expectation was for the best of all possible worlds that you were going to get very co-operative 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 like early to mid-March. And since then we’ve been flat and maybe a little bit down. Nvidia’s off 10 per cent from the peak. The S&P is off 3 per cent. That’s not a sell-off, right? That’s caution. But you definitely had a palpable shift from the kind of ebullience, the, you know, untrammelled ebullience of the last couple of months.

Katie Martin
Yeah, 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 are markets gonna really suffer from here or is it a blip. Is this something that we can where maybe we just kind of float around current levels on stocks for the rest of this year? But yeah, just to like really underline the point, the whole mood has changed. Been a big vibe shift.

Ethan Wu
Yeah. I feel I need to say, it’s not that bad. You know what I mean? Like it really, really is not. Yes, ideally inflation would be closer to 2. Yes, ideally there would be a clear Fed outlook. Yes, ideally there would not be a gigantic potential cluster mess in the Middle East. But from the perspective of a US 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. And 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, it’s gonna feel like a disappointment. But like, on the whole, it’s not that bad.

Katie Martin
Yeah. For disappointment, Ethan, if I can leave you with no other advice. (Ethan and Katie laugh)

Ethan Wu
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?

Katie Martin
I mean, you’re wrong. This is the main thing here. (Ethan laughs) Let’s just bear this in mind.

Ethan Wu
But Q3 cuts. I mean, that’s a little ambitious. People are talking about November, December, not Q3.

Katie Martin
Yeah, Q3 is looking a little ambitious. But look, you know, 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 the quarter. But it’s a conviction weakly held, put it that way.

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Ethan Wu
I will not be buying you a pint until at least Q4 of this year. Just in all fairness, in all fairness.

Katie Martin
OK. I look forward to it. It’s gonna be delicious.

Ethan Wu
All right. Sounds good. We’ll be back in a moment with Long/Short.

Welcome 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?

Katie Martin
I am long whoever is doing the PR for Liz Truss.

Ethan Wu
(Laughter) Oh my God, she’s so cool. I really, I love her. I love her, man.

Katie Martin
(Laughter) 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. 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. She 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 the 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.

Ethan Wu
I know I said this last time we talked about Liz Truss, but the name of her book, Ten Years to Save the West, is like a truly hilarious title because it’s like, oh, it’s actually not that urgent then. We can kind of put it off to year five or year six, like, oh, whatever.

Katie Martin|
(Laughter) Yeah. Ten years is a long time if you’ve only been prime minister for 44 days.

Ethan Wu
(Laughter) I know. Exactly.

Katie Martin
That’s like a lot of prime ministers you can cram into 10 years.

Ethan Wu
(Laughter) 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 Patti Waldmeir 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 happen. But this year we are getting two waves overlapping for the first time in over two centuries. Patti 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”.

Katie Martin
(Laughter) Apparently they pee a lot as well, I also read in that column. I learned a lot about these little critters reading that piece.

Ethan Wu
I did, too.

Katie Martin
I’m sure of it as well though. There’s just too many creepy crawlies. It’s not nice.

Ethan Wu
Yeah, like the photo that Patti had in her article kind of unnerved me. And one of the people that she quotes in this piece is somebody who’s doing like exposure therapy in preparation for the cicada onslaught.

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Katie Martin
Heavens. No, no, no, no. It’s a no for me.

Ethan Wu
Yeah. I guess I’m short. I guess I’m short. All right, 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.

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Unhedged is produced by Jake Harper and edited by Bryant Urstadt. Our executive producer is Jacob Goldstein. We had additional help from Topher Forhecz. Cheryl Brumley is the FT’s global head of audio. Special thanks to Laura Clarke, Alastair Mackie, Gretta Cohn and Natalie Sadler. FT premium subscribers can get the Unhedged newsletter for free. A 30-day free trial is available to everyone else. Just go to ft.com/unhedgedoffer. I’m Ethan Wu. Thanks for listening.

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