The Fed’s juggling act

You like central banks? Everyone likes central banks. Markets are obsessed with central banks and in the past couple of days we've had a bunch of them setting rates and telling the world what they think. On Wednesday we had the MacDaddy, the US Federal Reserve. And we'll get onto that in a sec. But after that, Super Thursday, boys and girls get on board. Rates decisions from Japan, Switzerland, Sweden, the Eurozone, UK.

Every now and then the schedules just sort of line up and you have a real day of it. This is one of those times. So what is the combined wisdom of the finest minds in finance? I'm gonna summarise here and say it's We don't know what's going on. Iran is bad. Iran is bad. Higher energy prices are bad. And we have no clue how much worse it's gonna get. Fun times. Today on the show, are interest rates gonna hold steady or even head higher to tackle inflation, or are they heading down to deal with a

This is Unhedged, the Markets and Finance podcast from the Financial Times. And Pushkin, I'm Katie Martin, a markets columnist here at FTHQ in lovely sunny London. Joined down the line from New York City by that guy, Robert Armstrong of the Unhedged. Um Rob kind of

Squidgy mood today, right? In the markets, it's all got quite dark quite quickly. Today's one of those days so usually before we start talking, I'm like, Oh, let me m let me call up a chart or two for me to look at while we're talking, just so I know what the actual numbers are.

And today was one of those days where like there's about fifteen different charts I wanted to call up. Like my my head feels like it's bursting with all the different things that are going on at once, especially in kind of central banking rates world. It's just really kicking off in an amazing way.

Yeah, it has booted off. We had the Fed decision on Wednesday, US interest rates on hold. Boring snoring, right? Except not because What Jay Powell, Chair of the Fed, was saying was yeah, this inflation business coming from energy prices. We had not anticipated this and it's quite bad. Well, he didn't exactly say it's quite bad. What he said was again and again about every forty-five seconds for the entire press conference was we don't know what's gonna happen. And I'm not gonna speculate.

Right. So like of the big question for him is And every central banker is. Can we ignore inflation caused by an energy supply shock, which is the inflation that appears to be coming down in the pike. And in theory, when they were all sitting at central banker school, what they were taught was you do ignore because tightening interest rates doesn't make more oil appear.

And you damage the economy. So like it gets you closer to stagflation rather than bringing the the the economy back in balance and bringing inflation under control. But And this week we seem to be specializing in big butts and I don't mean to be making a pun there. There is a big butt here. Yeah. Which is Powell used the word leak. Where he said sometimes this energy inflation can leak into core inflation. And even worse, it can leak into inflation expectations.

Right. And then you have to do something. Right? Like as long as the monster stays in the area marked energy, you're okay. But if it gets out of that special area, you have a real problem and they have to worry about that. But again, he said, we don't know if that's gonna happen. We don't know. We don't know. Don't want to talk about it. We don't know.

One of the little um phrases that has been sort of kicking around on my screen this week has been, you know, when you have some sort of Financial crisis. Governments or central banks can effectively just print more money and just push money into into the system. You can't print oil. Right. You can you can release strategic reserves but they have limits. You can run out of in theory, you can run out of strategic reserves just like you can run out of your normal reserves of of oil.

So that's why energy shocks tend to be so horrible for economies and for markets, because you can't just turn it off. And that's basically what a lot of central banks have been alluding to in the in the past couple of days, which is we can see this wave of inflation coming our way.

But first of all we c w we can't turn it around on our own. Second of all, we don't know whether this is just gonna be a little kind of one off, you know, bump higher in inflation or whether it's a meaningful long term shift. higher in inflation,'cause that's, you know, very much what Powell was saying at the press conference yesterday was, you know, sometimes you get a shock from something like tariffs that makes prices go higher, but it tends to be a sort of a one off thing.

It is plausible, like you say that it leaks and it turns into higher wage expectations, higher inflation expectations. It's tricky because there's so much pressure on the Fed to cut interest rates. That's obviously what Trump wants. Um but can it do it if inflation really takes hold? It's it's really sticky. You can't print energy molecules. You can only print dollar bills.

Yeah. You can't print molecules, even with clever 3D printers. It does it. There was a sub-theme there, which was, you know what? Underlying inflation, energy aside, is not getting better as fast as we would like. Which gives an unpleasant context this whole discussion. So the very first question asked in the press conference, which was asked by our former colleague Colby Smith, who traitorously went to the New York Times. She asked Are you guys gonna look through inflation?

Uh oil price inflation? Uh which is a question on everybody's mind. The chair answers as follows. I'll just read this. I thought it was interesting. The thing that is really important that we need to see this year is progress on inflation through a reduction in goods inflation as the one-time effects on prices of tariffs go through the system.

I mean, this is a weird answer to that question. You know, Colby's like oil and he's like tariffs. You know what I mean? And the point is, we still have half a point of inflation or so. That's in goods that they are counting on going away in the middle of this year. And if it doesn't, that makes the oil problem even worse. And then something else happened in the press conference, which was that another enterprising journalist

Asked. Well I'm looking at these numbers here, boss, and actually services inflation, which is the one most closely connected to wages, which makes it the one that makes everyone nervous. Services inflation X housing actually isn't better either. What do you have to say about that, Chair Powell? And he said it's frustrating.

Right. Yeah, welcome to the party, Chair Powell. So actually there is a percentage point of inflation above target. We're at three percent plus or minus on inflation. We're supposed to be at two percent. And it's services and its goods and it's not going away. And that is the context with which we are walking into an additional possibly inflationary shock from oil. So the context is bad too. Yeah. Yeah. So stuff was bad and now it's worse. Yes. And so

You turn from the Fed to the Bank of England. Right. So Bank of England today held interest rates at three point seven five percent. Again. Boring. But the decision was unanimous, which had not been anticipated. We thought there might be, you know, a a couple of voices looking for cuts to interest rates. But also, really importantly, they removed the guidance from their statement about the next move in rates probably being a cut. and this has smoked the guilt market. So U UK government bonds

don't like this at all. It in if you have a situation where you have higher inflation and higher interest rates, that pulls down the price of UK government bonds and pushes their yields higher, which pushes up Borrowing costs. Last time I looked at my screen, two year UK government bond yields were up a third of a percentage point. That doesn't sound Yes.

I know that doesn't sound like very much It sounds like a lot to me, Katie. That's bad. I I can't think of a thirty basis point two year day. The last time we had one of those I mean thirty basis. That's a marvelous one.

Maybe that was, you know, the spike and that that was the high for the day and then it kind of came back down a little bit, but the point is The shorter end of a UK of a government bond market is the bit that gives you the best reflection for what the market thinks is going to happen next to interest rates.

And so two years and five years, that's the part of the market that really feels the strain. It's just been absolutely smoked because the market had been expecting some more cuts in interest rates from the Bank of England, hunky dory, very happy. At a certain point today, and we're recording this on Thursday, that had shifted to the market fully pricing in two rate rises by the end of the year and maybe even a third.

So is this an overreaction? Hmm, maybe, but I think we all know that the UK has got a bit of an energy problem. We need that oil, we need that gas, we're not gonna be getting it. Where is the money gonna come from to help people pay their bills? Well, the government's gonna have to borrow some money to you know, to pad out the finances. That's not good for borrowing costs. So I'll be honest, I'm not loving the sight of this very much. Yeah, I would say not. I mean for our civilian listeners.

The two year bond yield, government bond yield, is generally thought of as a kind of proxy for what central banks are gonna do with rates in the coming months, right? So You know, th there's like this rule in finance you have to say. The the policy sensitive two year yield and um the policy sensitive two year yield since the beginning of the war in the US has gone from three point three seven three eight percent to three point eight three.

So it's more than a forty base point. That's a meaty move. Which means basically Something like two rate cuts that people had been hoping for. have been unceremoniously removed from our projections, the market's projections of what the market is gonna do. This is starting to get into economically meaningful territory. And you know, we've been saying on shows previous to this, isn't it interesting that the markets are taking this In strike.

And now I have to say, maybe the bond market is not taking this war in stride after all. Right. And stock markets can ignore oil prices for a bit, but but st but stocks investors are really scared of the big big bad bond market. And if the big bad bond market keeps on doing this Yeah. Eventually the message gets through. They're m they're more scared of bond yields than they are of oil prices.

So then yeah, we had the European Central Bank again held rates at two percent. Boring. The sixth meeting in a row, they've done that. Also boring. But They said soaring energy prices are going to have a material impact on inflation in the short term. They think inflation um is gonna head up to two point six percent this year. They were previously thinking one point nine again. I know to normally civilians that doesn't sound very much. That's a lot.

Meanwhile they lowered the um economic growth forecast to zero point nine percent from one point two previously. Now, I know one point two is not very much to start with, maybe we're kind of, you know, bald men arguing over a comb, but That's not great. If you have slowing growth and you have accelerating inflation and you have an energy shock that central bankers can't fix on their own Then we are approaching what I like to call squeaky bum time. This is getting

Butts, bums. We have a lot of rear end activity on the show too. I mean look the SP five hundred is starting to notice since the start of the war. The S P five hundred, the most resilient stock market in the world, is uh is down about four percent this year, right? J just since the start of the war. So that's not nothing. And there is an irony here. Which is that Europe and Asia are suffering more. from America's decision to go to war than America.

Again, thanks for that. Yeah. You know, we went into this situation with Stronger growth rate and quite low unemployment and all the good things. Stacks of your own oil. And stacks of our own oil. So basically, you know, the inflation problem is gonna be worse for Europe and Japan. than it is for the United States. And the really hard decisions that, you know, central bankers, policymakers, investors are all gonna have to make are gonna fall the hardest on places like Japan, Europe, the UK.

Southeast Asia. Thailand, Philippines, Malaysia, they they need those energy supplies. And also th there's an oil analyst I was uh speaking to earlier today and he was saying, you know, the the tragedy of this is that, you know, oil products are really important part of manufacturing fertilizer. This is a an important part of the food chain apart from anything else.

at some point this will translate into higher prices for the food on your plate, which is kind of all well and good perhaps if you're Rob Armstrong, it's less all well and good if you are in, you know, a poorer country like Thailand, Malaysia, Philippines, There's gonna be an awful lot of people who are gonna feel this this damage in ways that they h perhaps hadn't anticipated. And and and again, I think we've mentioned this on the show before, but like

analysts in the oil market are like freaking out here. They've never seen anything like this. No, they're saying this is like this is COVID size horrendousness. And and it just feels a little bit today because we have central banks that have said, Yeah, this is slightly horrendous actually.

This feels like it's just been the point at which like a lot of people in stock markets and bond markets sort of wake up and think, Huh, maybe this is not just some sort of little, you know, storm in a teacup in energy markets. Maybe I need to worry about this more than I have been so far. We don't know how long this war is gonna last. And I think the takeaway from the show is that. So far most risk asset market.

have been able to take this war very much in stride. But in the last few days we have seen the bond market start to change its mind. And this is a serious development that investors have to take seriously.

Yikes! So I'm afraid, listeners, not much to cheer in the podcast today. Nonetheless, we'll be back in just one minute with long short. 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, what you saying? At a bleak moment in geopolitics. and a freezing cold moment in weather in New York City. I am long the NCAA men's basketball tournament. Every year at around this time when all seems lost, we have this great

single elimination tournament and all these weird teams you never heard of playing each other. And it's just like an affirmation of youth, life, energy, and I'm I'm rooting for the Prairie View A and M Panthers, who are sixteenth seed taking on the number one Florida Gators tomorrow. Let's go Prairie View. That sounds like the FA Cup. The magic of the FA Cup. There you go. S I am short black snot. So Yeah.

It used to be that when you went around old London town, like, you know, ten, twenty years ago, you would come home and you would have black snot in your nose. However What because of pollution? Yes. Were you still burning coal? Were you were you born in like Dickens, England? Oh Tony Tim has black snout again. Not quite as old as you. However, I'm excited to report that London is among nineteen global cities that have achieved remarkable reductions in air pollution.

Slashed levels of airway aggravating pollutants by more than twenty percent since twenty ten. You can see it in the snot, and it and your snot is not black anymore. So yes, short black snot, long London air quality, further. This is Unhedged, the Snot Podcast from the Financial Times and Pushkin. I'm Katie Martin and I have a healthy airway. We will be back with more searing snot analysis on Tuesday, so listen up then.

Unhedged is produced by Jake Harper and edited by Brian Erstadt. Our executive producer is Jacob Goldstein. We had additional help from Topha Forhead. Cheryl Brumley is the FT's global head of audio. Special thanks to Laura Clark, Alistair Mackey. Greta Cohn and Natalie Sadler. FT Premium subscribers can get the Unhedged newsletter for free, and a 30-day free trial is available to everyone else. Just go to FT.com/slash unhedged offer. I'm Katie Martin. Thanks for listening.