Transcript: Have rates peaked? 

This is an audio transcript of the Unhedged podcast episode: ‘Have rates peaked?’

Ethan Wu
All year in markets, there has been, give or take, one question, which is, like a kid in the back seat, are we there yet?

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Investors have been wondering if the Fed is done raising rates and increasingly they think it is. Markets have rallied almost 11 per cent in the month of November on the back of expectations that the Fed is just about done. Today on the show, peak rates euphoria. This is Unhedged, the markets and finance show from the Financial Times and Pushkin. I’m reporter Ethan Wu here in the New York studio, joined by FT markets editor Katie Martin in London, who heroically subbed in for me on Thursday while I was enjoying Thanksgiving here in America.

Katie Martin
I have to admit, I’m not jealous of that many aspects of American culture, but I do like the idea of Thanksgiving.

Ethan Wu
This is the national gorging day, and I certainly participated at a “friendsgiving” party that I was at. We ended up, you know, it was a potluck-style affair and we didn’t co-ordinate the food well enough. We ended up with seven pies.

Katie Martin
Wow.

Ethan Wu
And, you know, we didn’t finish all of them, but I certainly partook in a certain amount of pie eating, which has left me feeling, frankly, Katie quite euphoric today.

Katie Martin
Well, I am also feeling euphoric because of rates. It’s a bit weird that there’s this idea of euphoria, like people are literally having parties in the streets because of interest rates. But look, the lingo is what it is.

Ethan Wu
Did you replace the Thanksgiving holiday? You were jealous that we have Thanksgiving, so you replaced it with getting really, really excited about interest rates?

Katie Martin
Yes. I shall be observing this day from now on.

Ethan Wu
So the market reaction has been pretty unambiguous. You know, across the board in US markets, it’s been stocks celebrating, bonds celebrating, credit spreads are tightening. It’s very much the vibe is soft landing. You know, rates have peaked. They’re going to come down. And that gives everyone kind of a good feeling. It’s the opposite of what we saw in 2022, which is when rates went up, it killed the mood. Everyone’s feeling terribly dour, even though we’re printing, you know, 500,000 jobs a month, everyone’s feeling like we’re on the brink. Now it’s kind of the opposite. You know, falling rates are a bit positive to some. It’s, you know, a bigger pie at least as far as investors are concerned. And everyone’s feeling pretty good, it feels like.

Katie Martin
Yeah, it’s all about the pies for you, huh? So, yeah, the market has decided, rightly or wrongly, that the top is in, right? The rhetoric, if you like, from big central banks, chiefly the Fed, is OK, we’re gonna tread carefully from here. We’ve raised rates really fast, really high. Everybody knows the interest rates have these long and variable lags. And so, no, the economy is not sinking into a giant hole yet. But let’s kind of step back from this rate-raising cycle and see what happens next and not just keep on plugging on. So the guidance from central banks is, OK, inflation is kind of under control. Let’s just take it easy for a bit. The market has taken this and run with it. Really run with it. So you have, for example, as you say, stocks up like 11 per cent since the end of October in the States. That’s like, a lot. So we’re up 18 per cent year to date on the S&P. Who would ever have thought it? Not I, for a start.

Ethan Wu
It’s a good year. Really solid.

Katie Martin
Really solid. Can’t knock it. We’re up 36 per cent on the Nasdaq Composite. So all those kind of very techie stocks that love, love, love low rates have just gone completely off to the races. In the bond market, so the government bond market is supposed to be like really boring. It’s supposed to move really slowly. That was how it used to work in the good old days. But it has also kind of really got its rally boots on. So you see, when yields fall, that means prices have risen. So yields were up at 5 per cent on the 10-year US Treasury in late October. That’s come right back down from 5 per cent to about 4.4-ish per cent. So the moves are so big that some investors are telling me, I just, I can’t deal with this. This is actually putting some sort of slower-moving investors off because they wanted to catch the market when it was a 5 per cent. Now it’s back at something more like 4.5.

But the message from other investors is, look, if you missed that 5 per cent yield, then don’t be an idiot. Don’t miss 4.5. Get in this thing now. This is for real. Yields are only going in one direction. Fine. The question is, how far are they going in that other direction? And there’s quite a few assumptions baked into this that make me feel a little bit uneasy. You know, the market is saying not just that the Fed is done raising rates, but that it’s gonna to cut rates pretty quickly into next year. And I don’t know about you, Ethan, but I’m like, are you sure about that? I mean, what do you reckon?

Ethan Wu
Yeah. I know what you mean and we’ll definitely get into that. But Katie, you’re killing the euphoria, OK? I want to just bask in the glory of . . . 

Katie Martin
Sorry.

Ethan Wu
The rate cycle being over for a second.

Katie Martin
Fund sponge, yeah.

Ethan Wu
I mean, because I think of everything in terms of newsletters that I’ve written. Like, my entire calendar is what newsletter did I read on that week? You know, in mid-October, Rob and I were writing, frankly, like, you know, rather alarmed newsletters about the 10-year yield at 5 per cent and the term premium and the fiscal deficit and blah, blah, blah, blah, blah. And, I mean.

Katie Martin
Who will buy all the bonds? Everything’s terrible.

Ethan Wu
Who will buy all the bonds? So that October 19th is the day that 10-year yields peaked recently at a high of 4.996 per cent. Today, they are 4.404 per cent. I mean, that’s a 60-basis point move in the 10-year in a month or so. That’s a huge move. That suggests something has changed, if not in the fundamentals then at least in the market psychology. And I mean, I think there’s clearly concrete economic news that you can point to. The big one, of course, being inflation, right? We’ve gotten more inflation data confirming the signals that we’ve been seeing develop for some months, which is that inflation, however entrenched you may or may not be, doesn’t look as scary as it looked six months ago; that some of the stickier categories are moving back down.

The distribution of price increases, which is what the Fed I think really cares about, is shifting back toward being centred around 2, 2.5, maybe 3 per cent. And of course, you know, we’re not back at 2 per cent, still about 3 or so. But there’s been enough improvements in some of the kind of composition of inflation, some of the details, the under-the-hood elements that I think the Fed can feel a little calmer. And their willingness to say we’re on pause, we’re taking a break, we’re gonna evaluate suggests that they’re feeling less panicked, less in a rush to, you know, we’ve got to get rates higher because this inflation problem could really spiral out of control. That phase is over. They’re in kind of a strategic patience phase and they’re going to wait till it’s dead obvious that inflation is under control before they, like you said, start cutting or consider that at all. But that itself is kind of a phase shift for markets, that we’ve really confirmed that the Fed doesn’t need to have another 50 basis points or hell, 100 basis points tightening. It wasn’t so long ago that Jamie Dimon said yields would go, you know, rates would go into 6 per cent. That’s a change in markets.

Katie Martin
I think he might even have said 7.

Ethan Wu
Seven? Oh, man.

Katie Martin
Yeah. Like there was certainly a point, as you say, a few weeks ago where it started to feel a bit panicky and yields were just getting higher and higher and suddenly, like you said, there was this whole thing about who’s gonna buy the bonds, this fiscal deficit, this is all terrible. Yields just gonna keep cranking higher and that’s terrible for everybody. As you say, massive mood shift now. And there’s an enormous consensus that yields are gonna keep pushing lower. Something like 60 per cent of fund managers looking at the Bank of America survey that it puts out every month are expecting lower yields over the course of next year. There’s a, you know, pretty substantial positive bet on Treasuries, one of the biggest positive bets on US government bonds of the past couple of decades.

The thing that gives me pause is, is it really realistic that the Fed is going to cut, you know, particularly sort of early next year because a lot of this kind of fizziness that we see in the stock market is kind of predicated on the idea that, ooh, look, rates are coming down. But think about it. Think this through. Why would rates come down? The only reason why the Fed would cut interest rates when inflation is still running ahead of target is because something awful happened. It’s because there really was a hideous, massive recession. Do you really wanna be owning risky assets? Do you really wanna be owning, you know, stocks, tech stocks, all the rest of them, in the event that we get an actual proper recession that bites hard early next year? Not for me.

Ethan Wu
I think what the bulls are saying these days is it’s not just in a recession that the Fed would cut. They have a different scenario that they have in mind. This is the idea of like rates normalisation, which is what the Fed cares about is not necessarily the nominal interest rate, right? Like when you Google what is the Fed funds rate today? You’ll get some number. They care about the real interest rate, which is the policy-setting interest rate minus whatever inflation is. And the logic is that as inflation falls, that mechanically raises the real interest rate. So as inflation comes under control, the Fed may need to tactically just a little bit, you know, 50 basis points or something, lower nominal rates to keep the real rate steady. This is called normalisation. The idea is the stance of monetary policy stays the same, even though the nominal rate itself changes. And in theory, that would be a boost for markets.

I think, you know, my issue with that thinking is that, I mean, it’s optional, right? The Fed has total optionality over whether they decide now it’s time to normalise. You know, we gotta bring the real rate in line because inflation has come down or whatever. I mean, it could be a while before they’re really thinking about that and there’s no urgency to it. And trading on the expectation that that’s coming in the next couple of months seems, you know, premature without kind of indications that the Fed is seriously considering that, because, again, nothing’s forcing their hand to cut rates the way something was forcing their hand, namely inflation, in raising them. So I think I share your caution, Katie, on that.

Katie Martin
Yeah, I’m still pretty happy. Do you remember I bet you a beer that the Fed wouldn’t cut until at least the third quarter next year? Like I’m still pretty comfortable with that bet, actually.

Ethan Wu
It’s a decent bet.

Katie Martin
How you laughed at the time. It’s actually looking pretty decent.

Ethan Wu
It is. I think really, you were kind of ahead of the consensus. I’m seeing kind of Wall Street sell-side economics shops saying that, you know, the second half of ’24 is kind of when they’re expecting cuts.

Katie Martin
You heard it here first. When I launch my hedge fund I’m gonna like, crow about my superior rate-predictive powers.

Ethan Wu
The Katie Martin Long/Short Hedge Fund would have an incredible track record. I think it would be some of the greatest returns volatility of all time. (Laughter)

Katie Martin
But yeah, I mean, I think there’s a couple of things baked into that, right? One of them is like, these are the hard yards for the Fed. Getting from 10 per cent inflation down to about 4 per cent inflation is relatively easy and probably not actually that much to do with monetary policy, much more to do with supply chains and other stuff. Getting it from 4 down to 2, that’s the tricky bit.

Ethan Wu
Right.

Katie Martin
And we all remember all those very wordy papers from the IMF, you know, a few months ago saying do not relent too quickly on this battle with inflation. If you give up just when the finishing line is in sight, you’ve lost it. And people hear different things from Fed statements. And what I hear from them is, we’re happy with how things are going. We’re very pleased with ourselves for not tanking the economy, but we’re not gonna give up. We’re gonna keep at this to the end. So you can cherry-pick bits and pieces from what they say. But I’m not hearing a Fed or a European Central Bank, or a Bank of England, for that matter, saying yeah, that’s it. You know, I think they’re gonna stick at this to the bitter end. So absolutely makes sense to price in, for me, the end of a hiking cycle. But I would just be a little bit cautious on how far you take that in terms of when the cuts are gonna kick in.

Ethan Wu
To me, there is kind of a live question about how much of the the buoyancy that we’ve seen in US stocks recently is actually about the Fed or some other fundamental economic bet as opposed to a reaction to liquidity. And what I mean by that is, you know, broadly speaking, in the investing world, you know, if you have more cash chasing the same amount of risky assets, the prices of those assets are gonna go up. There’s more demand for them. And we’ve seen in the past month or so a pretty marked increase in the amount of liquidity kind of rushing through the US financial system. The reasons why are a bit complicated and if you’re interested, you can read about it in the latest Unhedged newsletter. But the basic point is when you have an uptick in the amount of cash chasing risky assets, those assets historically tend to go up. And that’s exactly what we’ve seen recently. It’s coincided with this market rally.

And also, if you look at the composition of kind of what’s going up the most, it’s like the big techs. It’s like the profit (inaudible) techs. It’s like bitcoin. It’s some of the stuff that we got used to consistently rallying in 2021 when there was, you know, a ton of liquidity in markets. It was that sort of stuff that went up the fastest. And we’re seeing not the exact same pattern. There are differences, but at least some echoes of the liquidity gusher era of 2020 and 2021 repeating in today’s rally, which makes me question how much of it is like a conviction bet on interest rates as opposed to, well, there’s more money in the system right now for various idiosyncratic reasons. So buy stocks.

Katie Martin
Yes, the chin-strokey kind of liquidity experts who think that everything can be explained away by Fed operations and by Fed balance sheet, you know, that they’re kind of sticking to their guns. And I’m not saying they’re wrong. But the fact is, you can’t argue with the wisdom of crowds. The market is telling you this thing is over. Right now, it feels like standing in the way of it is a bit of a silly thing to do. So the kind of easiest thing is to kind of go along with this. But I don’t necessarily think this makes 2024 an easy run.

Ethan Wu
I definitely agree. I mean, we’ve talked about it a number of times. What helps rallies turn into bull markets is hatred. When investors hate it, people can get convinced over time by rallying stocks that, hey, this is for real, this is for real. I don’t know about you, Katie. I’m feeling like investors feel terribly ambivalent about this rally. You know, some people are buying in to catch up, but for the most part, eh? Like, you look at positioning and all the positioning is pretty, pretty middle of the pack by historical standards. I don’t think people are particularly upset about this rally or greedy about it. There’s neither fear nor greed, and I think that’s a recipe for, OK, we’ve seen most of the juice left in stocks and it’s just gonna depend on what develops next in the economy, probably.

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Katie Martin
You want sadness. You’re a bad person.

Ethan Wu
(Laughter) Not sadness, Katie. Ambivalence. I’m ambivalent to this rally. But I’m not ambivalent about Long/Short, so let’s go there next.

Katie Martin
Nicely done. Nice. (Laughter)

Ethan Wu
All right. Welcome back. This is Long/Short, that part of the show where we go long a thing we love, short a thing we hate. Katie, everyone this year in finance, it feels like, has been forced by diktat to develop an opinion on Goldman Sachs CEO David Solomon and his DJing technique. Well, today, I am long D Sol’s DJing. Our colleague Joshua Franklin reported, even though he can’t do it in public anymore for PR reasons, he’s DJing at his daughter’s wedding, which I think is just lovely.

Katie Martin
The absolutely authoritative take on DJ D Sol’s DJing career and skills comes from Bryce Elder on FT Alphaville. (Ethan laughs) If you ever have a chance to look at him, he literally went to hundreds of DJs and asked them what they thought of DJ D Sol’s actual work. Read it. You will not regret it. So funny you should be mentioning just now ambivalence because I am neither long nor short. I am neutral. Because again, the Goldman Sachs theme here, Goldman Sachs’s asset allocation team put out its macro outlook for 2024. It is macro outlook 2024 season. Everybody, be excited about that. And it’s big take is we are neutral.

Ethan Wu
Mmm.

Katie Martin
On asset allocation. Tip of the hat there to John Authers from Bloomberg, formerly of this parish, who pointed it out in his newsletter the other day. But they say they are neutral — equities, bonds, credit, commodities, cash. They’re saying stay diversified, be kind of ready for anything. This kind of keys into what a few people have been saying to me recently, which is no one feels like making a really big call right now. Everyone is just like, I kind of give up. I understand that things happened this year that I didn’t predict and I understand that. I don’t understand things as well as I thought I did. And so the safest thing to do is just be diversified and be neutral on stuff. So, yeah, the death of the big idea. There it is.

Ethan Wu
Man. This show’s all about ambivalence, isn’t it? We started with euphoria and ended with ambivalence.

Katie Martin
That’s what we like to achieve.

Ethan Wu
(Laughter) This is the Hedged podcast.

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We have neutral opinions on just about everything. All right, Katie, thanks for being here. We’ll have you back soon, hopefully with some views this time, hopefully with some opinions. And listeners, we’ll be back in your feed on Thursday with another episode of Unhedged. Catch you then.

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, Jacob Weisberg and Jess Truglia. 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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