Transcript: Central bank lookahead

This is an audio transcript of the Unhedged podcast episode: ‘Central bank lookahead’

Ethan Wu
For the better part of two years as central banks have been raising rates, it’s been all about getting inflation back down.

[MUSIC PLAYING]

But now across the developed world, we’re entering a new phase of the central bank fight. Inflation has come down in England, Europe, in the US and central banks have to start to think about how they’re going to deal with crunch time. 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 as ever on Tuesdays by markets editor Katie Martin.

Katie Martin
Hey, Ethan, are you pumped for Fed Day? You excited?

Ethan Wu
I’m so pumped. You know, every Fed Day, I roll into the office at a cool 1:30pm because the press conference doesn’t start till 2:30. Statement doesn’t come out till 2. I take the morning, I relax. And then it’s an insane crunch for the rest of the day. It’s absolutely so stressful. But always a good time.

Katie Martin
Happy Fed Day to all who observe.

Ethan Wu
Always a good week to watch central banks. This week is especially interesting. We had a great splash in the FT a couple of days ago titled “Central banks prepare to rebuff investors over the path of interest rates” sort of spelling out the fact that, you know, markets see interest rates falling next year. Central banks aren’t quite there yet. But I think the piece highlighted a really important dynamic that we should talk about, both as the Fed, ECB and BoE meet this week and as we go into 2024. It’s a new game for central banks. They have to start thinking seriously about whether interest rates fall, how fast they fall, what should trigger them to fall? That’s now a live discussion very much in the market and also, I think increasingly among central bankers and economists, too.

Katie Martin
Yeah. This is a very delicate juncture for big central banks. And as you say, we’ve got the big three — the Fed, the ECB, the Bank of England — all coming up this week; Bank of Japan just before Christmas. Always watch out for the Bank of Japan. But anyway, that’s a whole other story.

We’ve got the big three this week. And yeah, the market is doing some weird stuff, right? So the market is effectively saying hooray for the Fed. They’ve somehow engineered the situation where they’ve raised interest rates really, really aggressively and they haven’t, like, nuked the economy. So they’re saying soft landing, everything is good. But at the same time, if you look at where rate expectations are, it looks like the market is expecting quite a lot of rate cuts from the Fed, like 100 basis points or so — that’s a percentage point in real money — over the course of next year. That’s a lot, you know, by sort of historical standards.

So these things can’t be right because normally, it would only be cutting interest rates if the brown stuff had hit the fan. Whereas the market is saying everything is fine and they’re still going to cut rates. So the Fed now has to — wouldn’t have to — but the pressure is to give some guidance to investors about what is going to happen next. And the danger is that if central bankers say, look, have at it, we’re gonna start cutting rates before you know it. They wouldn’t say that in so many words, but that sort of thing. Then the markets will go gaga. Bond yields will fall really fast. Stocks will rise really fast. And then guess what? You’ve got the inflation problem back that you thought you’d defeated. So really delicate time here.

Ethan Wu
Absolutely. Markets are forward-looking. It’s kind of a cliché to say, but it’s really important in this context because even without central banks really saying tonnes about how or whether interest rates will fall next year, you’re already seeing markets price it in like you’re saying, Katie, just looking really at the economic data and not at what central banks are saying. So then you can imagine if they actually actively started talking about interest rates cuts, you know, markets would absolutely lose their heads.

Katie Martin
Yeah. The thing is, if you’re expecting to dial in to watch the Fed press conference because you have a really fun life like that . . . 

Ethan Wu
I love my job.

Katie Martin
Then what you’re not going to get is Jay Powell saying no, sure, we’re gonna start cutting rates in March. And you’re not even going to find any journalists asking him any questions that are that specific. So this whole space is about tiny little hints, tiny little, not exactly a wink and a nod, but kind of very, very close to it. So central bankers have these, like, mad Jedi mind tricks where they kind of get across their message without saying it super explicitly so that there’s kind of plausible deniability about them having said, oh yeah, we’re gonna do this thing on this day. They just try and guide the market in their kind of preferred direction.

So what we saw, as you say, not so long ago, Jay Powell said something about it being a little bit premature to start cutting rates. But bear in mind, back in October, he gave a much more forceful, again, slightly kind of gnomic but nonetheless forceful message, which was, whoa there. So he said financial conditions have tightened significantly in recent months and longer-term bond yields have been a factor in this tightening. Now to the trained ear, that is a very clear message that guys, bond yields are too high. I don’t want them up here. This is like tightening lending faster than we want. So we want bond yields to be lower. So that was one of the big triggers that led to the reversal in bond yields just sort of in the autumn of this year.

What we have not seen is a pushback of a similar magnitude against the decline in yields that we’ve had since. So that is the Fed’s way of saying this is fine, this is fine. You know, we’re not going to tell you that you’re wrong in starting to price in these rate cuts. And so certainly this week’s big press conference is a big opportunity for Jay Powell to say, you lot have got this wrong. We’re not gonna cut as fast as you think we’re going to cut. Or to say, no, carry on as you were. You can keep you know, just keep at it.

Ethan Wu
One complication for Powell in his meeting on Wednesday is that not everyone’s, you know, reading his exact same script. In late November, one Fed governor. So people will know that the Fed is not just one man, it’s not just Jay Powell. It’s actually an entire board of monetary policy officials. And one of these officials, Fed governor Chris Waller, said the following in late November: If we see disinflation continuing for several more months, I don’t know how long that might be. Three months, four months, five months. You could then start lowering the policy rate just because inflation’s lower. It has nothing to do with trying to save the economy. There is no reason to say we will keep it — interest rates — really high.

And what Waller is saying there is that if you get a sufficient amount of good inflation news, which we’re not there yet, but we’re not terribly far from it. If you get enough good inflation news, then that would unlock the Fed’s ability to normalise policy rates, to bring down interest rates just a little bit, to keep the broader approach of monetary policy consistent. Because the restrictiveness of monetary policy, the amount that it slows the economy is set by the real interest rate, which is you can think of it kind of like the policy rate that the Fed sets minus whatever the inflation rate is. What that means is as the inflation rate falls, you’re actually kind of automatically tightening policy unless you lower the nominal rate, the headline rate, the policy rate alongside it. So that’s kind of one complexity, is that you have Fed officials out there talking about rationales for rate cuts. That’s not, you know, what you’d hear if you had kind of a consensus around, you know, well and truly higher for longer, right? And I think that does genuinely reflect there are different points of view on the Federal Reserve. There are officials out there talking about maybe we need one more rate increase. And you’ve got people like Waller talking about cuts within three, four, five months.

Katie Martin
And Waller is not one of your kind of, eh, cut it kind of guys, right? He’s one of the more hawkish members of the Fed’s rate-setting committee. So that’s why these comments really stood out. So he’s saying even if inflation is still above target, maybe it’s time to start cutting. So the market has got the bit between its teeth on this notion that rates are gonna start falling pretty soon. And yeah, I mean, Jay Powell knows better than I do whether they’ve got that right. So, again, it’s not just Powell and the Fed. There’s a similar opportunity this week for the European Central Bank, for the Bank of England to push back on some of the expectations around cuts there as well. The market is pricing in about 1.3 percentage points of cuts from the ECB next year. For the Bank of England, it’s more like 0.9 percentage points. This is a decent amount. But, you know, everyone’s gonna be sitting there eagerly with their little cups of tea and their mince pies saying, come on, have we got this right? Have we got this wrong? You know, give us a sign. Give us one of your kind of bizarre, elliptical central bank comments to help us understand if we’re on the right track.

Ethan Wu
One thing I don’t know if I totally understand about the ECB, Katie, that maybe you can enlighten me on is, you know, inflation in the eurozone is really surpri— headline inflation, that is, including energy prices, which are kind of a key component to European inflation. They’ve really surprised to the downside as oil prices have fallen globally. And the concern now seems to be core inflation. How scary does core inflation look in the eurozone right now, in your estimation?

Katie Martin
Yeah. So I think I’m right in saying the last headline inflation number from the eurozone was 2.4 per cent.

Ethan Wu
I think that’s right. Yeah.

Katie Martin
It was certainly getting very close to target. And the broad idea around Europe is that it’s much less able to withstand shifts in interest rates than the US is because so much more of lending is contingent on bank lending. Rather than going to the bond market, you go to your bank so you’re much more likely to get kind of floating rates. Whereby if the interest rate rises, then you immediately take a hit on next month’s interest payment on your loan. So you don’t have the same sort of mad system that you have in the States where you lock in mortgage rates for 30 years.

Ethan Wu
30 years.

Katie Martin
This is just like . . . 

Ethan Wu
The American way.

Katie Martin
 . . . completely alien to the rest of us. So we’re just not as shielded from interest rate moves in the UK and in Europe as you are in the States. So much more sensitive. You’re seeing more stress in economies like Germany’s. Let’s not forget a little while ago that Poland cut interest rates pretty hard. Yes, there may have been some kind of politics involved there, but nonetheless, three-quarters of a percentage point in one go tells you this is an economy that probably is not doing so great. So, yeah, you know, there’s a lot of investors out there who think that the eurozone quite possibly already is in a mild recession and that it’s time for the European Central Bank to sort of tap on the brakes and give companies and households and whatever a little bit of a hint that there are some rate cuts to come. But yeah, all central banks face the same issue, which is that if you let, if you give the market an inch, it will take a mile. And if you let the market think that higher for longer is over, lower for longer is back, hooray, then you will just go straight back to the inflation headache that you’ve been trying to kill.

Ethan Wu
And just to bring it back to the US for a second, you know, Jay Powell a couple of weeks ago made the comment that risks to the Fed’s so-called dual mandate, which is, you know, full employment and price stability, the risks have become, quote unquote, more balanced, meaning that he sees both the employment side and the inflation side, as, you know, comparably problematic, where, you know, it used to be the clear, clear, clear problem for the Fed and I’d say also for the ECB and the BoE is like inflation is way out of whack and we gotta really hammer this down. And now it’s become two problems that are kind of in tension, right? Inflation is coming down, but it’s still a bit uncomfortably high and there are signs of labour market slowing. I mean, the labour markets don’t look completely indestructible, although they do look pretty damn strong. And, you know, navigating what is becoming, you know, a growing tension between both of the goals that central banks want to target without tipping their hand to the market, right, and letting the market get ahead of itself. That’s really hard. And I think it’s going to be kind of an ongoing struggle in 2024. We’re gonna hear a lot about, you know, so-called communication challenges from the central banks.

Katie Martin
Yeah, big time. Big time. I mean, not that I think they’re gonna ask me to run any central banks any time soon, but I’d much rather be a journalist, thanks very much. It’s really hard.

Ethan Wu
Well, Katie, during Fed Day tomorrow, I really, really hope Jay Powell says something interesting because whether or not he says something interesting, I have to write a newsletter about it. And if he doesn’t say anything interesting, I will be there straining, stressing, trying to produce words.

[MUSIC PLAYING]

Katie Martin
He’ll say something interesting. Come on. Not all heroes wear capes. He knows the pressure you’re under.

Ethan Wu
Thank you in advance, Jay. I appreciate it. All right, Katie we’ll be back in a moment with Long/Short.

[MUSIC PLAYING]

Welcome back. This is Long/Short, that part of the show where we go long things that we like and short things that we do not. Katie, I am long Google losing an antitrust lawsuit to Fortnite maker Epic Games over Google’s App store. This is kind of a much-covered, much-heralded antitrust trial where Google was accused by Epic of, you know, cutting side deals with hardware manufacturers like Samsung and LG to basically prevent external app stores like Epic Games’s from being on the Google platform to Google software. And after just a couple of hours of jury deliberation, Google lost in this trial and Epic won. I am long this in general because I do feel antitrust scrutiny has been too quiet over the last ever. But at the same time, I do kind of feel torn because Fortnite is a dreadful game. And if the eventual long term outcome of this is that there’s more Fortnite and more people playing Fortnite and more skin purchases within Fortnite, I don’t know if that’s a better outcome for society, all things considered.

Katie Martin
But is it a David and Goliath thing? Are we kind of rooting for the Fortnite side just because they’re, like, not Google?

Ethan Wu
I mean, yeah, that’s another good point. It’s like Goliath and like a medium-sized Goliath. There’s no David. It’s like a, it’s a big kid punching a slightly larger kid.

Katie Martin
If I’m allowed, I’m also going to be long something. I am going to be long, everyone loves crackdowns on greenwashing, right? You know, like claiming that your investment product is gonna save the world or that, you know, your company, even though you’re an oil company, you’re doing your best to stop global warming, all this sort of stuff. In a way, it sounds sort of small beer, but I think it is quite fun that the UK competition regulator is looking into Unilever. They make stuff like household cleaning products and also like Dove soap and Lynx spray that teenage boys love spraying themselves in enormous quantities and saying, you know, some of the packaging here that’s sort of with all the kind of green leaves on the bottles might give a misleading impression about how recyclable the bottle is or how chemically the contents are. And, you know, I just think it’s a whole interesting new front in the war on greenwashing.

Ethan Wu
You know, Katie, when I was a teenage boy, not terribly long ago, we used Axe body spray, which I guess is the same thing as Lynx. And if you were not absolutely reeking of Axe, it had to be kind of coming out of every pore of your body. You just weren’t with it. You weren’t cool.

Katie Martin
I mean, cool, maybe. But I can assure you, I own two teenagers. One of them is a boy. This stuff really stinks the house out. And yeah, they do indeed wear it in vast quantities.

Ethan Wu
Well, Katie, if there is anything to be long, I am long us doing six months of these shows every single week minus your sabbatical.

Katie Martin
Is it six months? This year has really, really flown by, hasn’t it?

Ethan Wu
Yeah. It really has.

Katie Martin
It has simultaneously like been a really long year. (Laughter) I really need to go and sit in a dark room somewhere and also just zip by.

[MUSIC PLAYING]

Ethan Wu
Well, hey, listeners, we’re grateful for you listening. If you’ve been listening since June, let us know. I’m at ethan.wu@ft.com. And if not, we’re happy to have you too. Thanks for being here, Katie. And listeners, we will catch you again on Thursday.

[MUSIC PLAYING]

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.

[MUSIC PLAYING]