Transcript: Can the US stock market stand 3% US inflation?

This is an audio transcript of the Unhedged podcast episode: ‘Can the US stock market stand 3% US inflation?’

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Katie Martin
Just when you thought it was safe to get back in the water, US inflation is back. Very scary times. The inflation rate picked up in data that came out this week and the market not been expecting that. I wanted to get the smartest person I could find to talk to you about what’s going on here but unfortunately, Ethan Wu is not around, (Robert laughs) so we have instead Rob Armstrong. How are you?

Robert Armstrong
Oh. I don’t even have . . . I’m fine.

Katie Martin
You’re missing Ethan.

Robert Armstrong
Yeah, it’s tough. Who’s gonna do all the work now that Ethan’s not here?

Katie Martin
Who’s gonna do all the work? It’s gonna have to be you. It’s certainly not gonna be me if your podcast . . . I didn’t introduce myself. I’m Katie Martin, I’m a markets columnist here at the Financial Times, and this is the Unhedged podcast on finance and markets from the Financial Times and Pushkin. So we are going to ask, Rob and I, exactly how worried should we be about this little pick-up in US inflation? Rob, give us the numbers. Like what’s going on here?

Robert Armstrong
OK. Let’s just look at the consumer price index, the basic, simple, the core consumer price index which is your basic prices of things not including food and energy, which are too volatile to care about. And if you smooth them over a three-month average, they’re sort of not going down since the summer, right? We’re cruising along at a bit over two. You sort of pick your inflation indicator. And one of the things nerds like us like to do is argue about the best one. But you pick your inflation indicator and a lot of them look alarmingly like they were going down, down, down since the beginning of ’22 and since sometime in the middle of last year, they seemed to be going sideways, sideways, sideways.

Katie Martin
We have got a little bit stuck. So your absolutely basic CPI reading came out earlier this week. It’s running at a year-on-year rate of 3.2 per cent in February. The market had been expecting 3.1, I think.

Robert Armstrong
And the Fed wants 2.

Katie Martin
The Fed wants 2 so bad. And it was 3.1 last time. So look, this isn’t a massive rise in inflation. But as you say, it just makes people think, oh but wait a minute. I am sure I read in some clever newspaper somewhere that inflation was falling. And this is not falling.

Robert Armstrong
Yes. I want to talk about a few other spooky things. The Fed cares almost more about what people expect inflation will do than they do about what it will actually do, because it’s our expectations that make us do things rather than reality. And if you look at various measures of inflation expectations, some of them are still falling, but not all of them. Break-even inflation, which is a market-derived measure of expectations, that has ticked up a tiny bit in recent weeks. So that is not very good. And generally, you look at the economy, Katie, and we’re still churning along, creating 200,000 to 300,000 jobs a month. Wages are still growing at like over 4 per cent, I think; somewhere in that range. Why would inflation go down, you start to ask. Economy is running hot.

Katie Martin
That’s it.

Robert Armstrong
Right? Generally it takes a cool economy to slow inflation.

Katie Martin
Yeah. Are we moving from a world where inflation initially picked up really, really sharply because of all the supply chain issues that we all remember from happy fourth anniversary, Covid-19 lockdowns. It’s been real. But if it’s not Covid supply chain gubbins that’s really doing the damage here, then what is doing the damage here? What is really pumping up inflation?

Robert Armstrong
It’s not energy; that’s excluded from the core, and that has been falling. And as always, when you look at the small items inside the large inflation indices, it’s weird stuff like car insurance, hospital prices, food away from home; all this stuff, as anybody knows who’s been in a restaurant recently knows that food away from home has not gotten any cheaper. So a lot of it is kind of consumer services we all use. But I don’t know, you know, why won’t those things calm down? That would require someone probably a little smarter than me. But the point is that as measured, that is not happening.

Now, there is a story about why this will all get better, which is that the official measures of inflation, a huge component of those measures comes from housing costs. And the way, without going into the gory details — and they really are gory — the way the government measures housing costs causes those measures to lag the actual market quite a bit. So and I think we’ve talked about this on the show several times that if you look at an index that’s very timely, like real estate companies like Zillow keep timely indices of rents and housing prices. Those have fallen a lot. And we’re just sort of sitting around waiting for the fuddy-duddy government measures to catch up with the more timely ones. And once that happens, we’ll get back to 2 and there will be peace and happiness throughout the kingdom.

Katie Martin
Throughout the land. 

Robert Armstrong
However, listeners who keep up with this sort of thing will have noticed in things like the Case-Shiller index that housing prices have started to rise again on a year-over-year basis. So — and this is something I should give credit to Torsten Slok of Apollo, who pointed this out to me yesterday — what if housing is not coming to the rescue of inflation? That would be very bad indeed.

Katie Martin
Now, the reason why we all obsess about this stuff is firstly because it’s just interesting and we’re quite boring people, and secondly because this is like the biggie for setting US interest rates which are kind of central to how, you know, markets (inaudible). That’s what they’re there for.

Robert Armstrong
That’s what they’re there for. Interest rates are first and foremost there, or at least half the time they’re there, to control inflation.

Katie Martin
Now that, you know, we’ve been on a bit of a kind of wild ride, right? So the market went from being absolutely terrified that interest rates were gonna stay really high for a very long time, this higher-for-longer kind of dynamic. Investors have given up on these kind of slightly bizarre expectations that the Fed might cut rates six times this year. Like, we’ve now already got back down to about three times this year, which is kind of that’s in line with what the Fed has suggested.

Robert Armstrong
So let’s throw some numbers out there. At the height of the good vibes period, when everybody thought inflation was dead and everything is perfect, la la la, the expectation was that at the beginning of next year, the Fed would be at 3.5 per cent.

Katie Martin
Get out of here. We’re now at 5 and a bit, right? So that’s a fair (inaudible).

Robert Armstrong
Yeah, we’re at 5 and a bit. So some realism has entered the market. And we are now at 4.5 or so. So half of the euphoria has left. But that still has the Fed cutting four times this year at a moment when there’s a good case to be made that inflation is going sideways and is not down to target.

Katie Martin
So here’s the thing. This is kind of where it gets really sticky, right, is that markets have spent like the last sort of two years constantly kind of jumping up and down and saying, oh, look, the Fed is gonna cut rates. And the Fed’s been saying, listen, boys and girls, we’re not gonna cut rates until this inflation thing is finished. I don’t know how many times we have to say this.

Robert Armstrong
We have to tell you.

Katie Martin
And so policymakers — not just at the Fed; also, you know, the European Central Bank and the Bank of England, kind of everywhere — are fixated on the idea that they don’t want to be the cohort of policymakers that fail to kill inflation and leave it to be a massive problem for the next few decades. So they are absolutely determined to kill these things.

Robert Armstrong
I have always put this point that you made, which I strongly agree with in terms of the kind of asymmetry of reputational risk for central bankers. If you are the central banker who kept rates a bit too high and you maybe caused a mild recession, or the economy could have been marginally bigger if it weren’t for you, you’re remembered as maybe not brilliant, but at least tough. If you’re the one who lets inflation run, they’re like making jokes about you in economics school for 100 years.

Katie Martin
Jay Powell does not want to be.

Robert Armstrong
Yeah. Like Arthur Burns is the name, you know, and it’s like, you know, it’s like, (speaking in falsetto) ooh, who’s Arthur Burns? You are. La la la. (Speaking in normal voice) Arthur Burns, for those of you don’t know, was the chairman of the Federal Reserve from 1970 to 1978, a period which I remember for its massive increase in the price of candy bars.

Katie Martin
The ghost of Arthur Burns stalks the corridors of power and monetary policy. So nobody wants to be Arthur Burns, least of all Jay Powell. So that’s, I guess, why we’re starting to see, you know, already, like I say, the expectations for when the cuts are gonna start have already been pushed back. Now they’re getting pushed back a little bit further.

Robert Armstrong
Yeah. But they still could, as people have begun to whisper, what if the next move is a hike?

Katie Martin
Get out of here, Rob Armstrong.

Robert Armstrong
(Inaudible) rates. I mean, I’m not . . . I wanna be clear that I’m not really sure, as ever, my ability to predict this stuff approaches zero. But you can’t look at the evidence now and flatly rule that out as a hilariously stupid thing to say.

Katie Martin
Well, it comes up in polite conversation that I have with investors all the time. They’re like, look, we have to kind of build portfolios that can deal with a number of different scenarios, right? The Fed has to cut rates super fast because this horrible recession that we’ve all been waiting for for two years and has not materialised, materialises. Or that something completely wacko happens with inflation. That means that maybe they don’t cut at all. Or maybe, you know, again, whisper it, maybe they have to raise rates again, get that whole thing restarted. So yeah, it’s not completely beyond the realms of possibility, right? But I guess, you know, the question that I feel our dear listeners will be burning for us to answer for them, Rob, is can markets handle it? Like, is this gonna be OK or is this going to tip stock markets off the edge?

Robert Armstrong
OK, this is the point in the conversation where I usually deliver the tiresome lecture about how interest rates and stock prices are not connected in a linear way.

Katie Martin
Can you just abridge that lecture just very slightly for us today?

Robert Armstrong
The tiresome lecture says we all think lower rates, higher stocks because that has happened often in the recent past. But in fact, if you look at the long history of these things, it depends a lot on the reason rates are going up and down and the relationship can be quite variable over time. And in fact, you can see that in very recent history, which is that for a lot of ’22 and ’23, the Fed was raising rates and the stock market was going up. Of course, you know, they were raising rates and the stock market was going down in ’22. That changed in ’23. But this is just an illustration of the point that the relationship is variable.

Katie Martin
It is, it is. But what has struck me and look, it’s only, you know, a matter of hours, honestly, since the inflation numbers came out. You know, it’s a day or so. But you know, I think this time last year, if the sort of headline basic inflation reading had come out 0.1 percentage points above where the market thought it was going to come out, the markets would have freaked out because they were completely obsessed with where interest rates were going and what was gonna happen to bond yields. This time around, again, you know, if I’m wrong by Friday afternoon, I’m wrong by Friday afternoon. But right now, the markets are kind of fine. They’re still hovering up by, you know, pretty close to record highs in the US.

Robert Armstrong
Do you know why? Do you know why? There’s a one-word answer for why markets do not care about the rate of inflation if the stock market does not care about the rate of inflation.

Katie Martin
Share it with the class, Rob, share it with the class. Go on.

Robert Armstrong
The word is Nvidia, because . . . 

Katie Martin
The only thing that matters!

Robert Armstrong
. . . there is this. You may not have heard of this company, OK, but there is this American computer chipmaker. And current market expectation is that the market cap of Nvidia this time next year is going to be the size of the Milky Way, and it will actually create more wealth in the coming 12 months than has ever been created in the history of mankind. So because of this, because this is true about Nvidia, what inflation does and what the Fed does for the time being does not matter.

Katie Martin
Yeah. Well, there was actually a potentially sensible reason for that, which is that the market has moved on from thinking, mmm, Nvidi-who? Surely they need low interest rates to carry on their kind of R&D spending and kind of be a proper, important company. But now, it’s clearly a proper, important company in and of its own right. So stocks are kind of pretty happy, not because they’re like high on the last fumes of the kind of potential that rates might fall again but because like, these companies do useful things and have really good revenues to show for it, so.

Robert Armstrong
Yes, and that’s an important point to make that companies are growing well, earnings are pretty good, a lot of parts of the economy is pretty good. That is all fine. The reason I mention Nvidia is simply that one has to keep in mind how quickly the dominant narrative in stock markets can change.

Katie Martin
100 per cent, yeah.

Robert Armstrong
Until a year or two ago, the dominant narrative was the Fed. Now the dominant narrative is tech stocks and a strong economy and artificial intelligence. And so my answer to your question, which is will the market be able to handle it if there are no cuts this year and possibly even a rate increase? Clearly, maybe. In other words, if the current, if the current market narrative is sustained, it can. It can do all that and more. But that narrative is fragile. You mix a rate increase with a slightly disappointing earnings forecast from Nvidia or Microsoft or whoever, then it becomes a very difficult combination for high stock prices to bear.

Katie Martin
If I were a betting person, I would at least bet that if we don’t get rate cuts soon, you know, if they’re pushed out later than June, can the market handle that? Yeah, I reckon it can. I think that’ll be all right. If they start raising rates again, then we’re just going to have to burn this podcast. Make sure no one can ever listen to it again and pretend we never had this conversation. But, you know, yeah, if that happens, then that would be significantly uglier.

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So on that happy note, we’re gonna have to leave it there. We’ll be back in a minute with Long/Short.

Robert Armstrong
Yup. Bye.

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Katie Martin
All right. It’s time for Long/Short, that part of the show where we go long a thing we love, short a thing we hate. Rob, are you long or are you short?

Robert Armstrong
I am long and I am long something that you might, for all I know, hate. And our listeners in America may not know what I’m talking about, but I am long Greggs, Katie.

Katie Martin
Oh, beautiful.

Robert Armstrong
Greggs, for those of you who don’t know, is — well, how would you describe it? It is a British food chain. Is that, would you call it fast food?

Katie Martin
I certainly would. It’s baked products. It’s doughnuts.

Robert Armstrong
Baked products.

Katie Martin
It’s pasties. It’s pies. It’s cheese slices.

Robert Armstrong
For the non-British listener, a pasty is a food-pockety kind of thing with flaky pastry on the outside and something delicious on the inside.

Katie Martin
That’s a good summary.

Robert Armstrong
It’s very affordable. I like eating there. I think the coffee’s fine. The stock is basically single-handedly holding up the FTSE 250. It’s great. That there is a stock market success story in Britain is great. And I think the food is good. I wish it would come to America.

Katie Martin
I just don’t know that it would fly.

Robert Armstrong
No. People would be like, what is this place? Yeah. They would have no idea. It would fail.

Katie Martin
Get this out of here.

Robert Armstrong
I still wish it was here. They can build a franchise just in my apartment.

Katie Martin
kay. So you are long Greggs. We should remind our listeners at this point. This is not investment advice. And if you listen to us, and specifically if you listen to Rob, you need your head seen to.

Robert Armstrong
Yeah. Bad things happen.

Katie Martin
But I tell you what I’m gonna be short here. And again, this is not me with my personal money or a personal recommendation, but people are short Tesla. I don’t know if you’ve seen.

Robert Armstrong
They’re making money at it too. Tesla has been acting poorly.

Katie Martin
Tesla is down like . . . I don’t know if you’ve noticed. Like, that stock is down a third this year. This year. It’s March. And the index is up 8.5 per cent. So something has gone badly wrong.

Robert Armstrong
And perhaps more notably, it is down at a time when other loopy, rather speculative assets are up, like bitcoin’s at an all-time high and Tesla is down. What kind of world is this?

Katie Martin
What kind of crazy world is this? And so earlier this week, Wells Fargo downgraded Tesla’s stock. (Both make mock shocked noises) Its target for the stock is $120. It’s now about 170. And the bank’s previous forecast was 200. And you know, there’s a certain point where you start to think, is this whole like fairy tale for this stock, is it unravelling?

Robert Armstrong
Like the company, don’t like the stock. So I’m with you. Let’s short it together, Katie. And all together now: this is not investment advice.

Katie Martin
This is not investment advice.

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And Rob’s stock picks are routinely terrible, so we should leave it there. Rob, hope to be in the studio chatting to you soon.

Robert Armstrong
Cool. Talk soon.

Katie Martin
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 Cohen and Natalie Sadler.

FT premium subscribers can get the Unhedged newsletter for free. The 30-day free trial is available to everyone else. Just go to ft.com/unhedgedoffer. I’m Katie Martin. Thanks for listening.

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