50 bps Fed Cut Now 'Off the Table'

Hello and welcome back to The Trading Floor, and we've got 3 topics up for discussion this week. Odds of a 50 basis point rate cut from the Fed have dramatically reduced since the last time Piers and I spoke, so the reasons why, and particularly we'll talk about the US CPI report this week. Then we also had the first televised debate between Trump and Harris, and Trump trades are being dialed back even more following that debate. So we'll re-explain a little bit about how that works and what you might expect next and the impact the elections are like to have on global markets. And then finally, the third topic, Goldman Sachs came out, spoke on Monday of this week and said they're going to post a $400 million hit to Q3 results as it unwinds its consumer business. Not all bad news though, in the M&A world there's they might be in for landing one of the biggest fees in an M&A deal for many years, which we'll also touch upon as well in Stephen's absence next week. So Piers, let's go into the, the US CPI report first.

Yeah, so inflation data dropped yesterday. We're recording this Thursday, so that was announced yesterday, pretty much bang on 24 hours ago, and Yeah, I mean, it was a mixed bag and actually quite an interesting market reaction as well, because initially, um, well, I guess, where do we start? Because the headline inflation reading, which is kind of what I guess initially everybody looks at, looks like inflation had dropped sharply. So actually the headline was 2.5%, okay? So CPI year on year 2.5% in August. That was a sharp decline from July's 2.9% and actually lower than expected. I mean, we were expecting a drop to 2.6%, but it went one notch further down to 2.5%. And look, it's notable because that is officially the lowest inflation print since February 2021. And so it's like, all right, great, it does seem that that very annoying flat period of inflation. Because just to remind everyone, June 2022, US inflation peaked 9.1%. Between June '22 and June '23, it, it came off sharply from 9% to 3%. And then from June 2023 to June 2024, it basically flatlined at 3%. Really annoying, didn't quite make it down to that 2% target. Okay, what's happened in the last 2 months is we're not at 3 anymore, that flat line, we've broken it and we're heading down again. Okay, so it looks like we're well on our way to the 2% target for the Fed, and it's like that annoying stodgy period of the last 12 months is over. So on that basis, good news for the Fed, full green light get cracking on your rate cuts. And you can— some out there might say, wow, okay, maybe you should be stepping up your rate of cutting, um, maybe look at a 50-point cut in September next week rather than 25.

Yeah, so a lot of people have put that as an emphasis, the, the 50 or not kind of move. So the 50 basis point trim in rates on the 18th of September That's now down to 14%. Last time you and I spoke, a week or so ago, it was 50%. It was basically a toss-up, 50/50. So why did the market take the report as such a clear signal then that it's more likely to be 25% and not 50%?

Well, because they listen to the, to the Market Maker podcast, and so they obviously heard— the market obviously heard what we were saying last week.

Well, you know, shout out to you. I did see the chief economist of BlackRock spinning your line about interest rates for the rest of the year. So she's obviously following, following the show.

She needs to get her own material. But look, the reason why, because when I talk about that headline reading, you'd expect the chances of a 50 cut to have gone up. And it's gone the exact opposite way. So it's now much less likely. It was as far as I no, my data anyway, it was— did you say this? It was 34% chance of a 50 cut before Wednesday. Afterwards it was 15%, right? So it's dropped sharply. So why is that? And that's because we don't just look at the headline CPI reading, we then go under the bonnet a little bit and we look at things like core CPI, okay? And then we don't just look year on year either. So that figure of 2.5%, that's the prices in August 2024 versus prices in August 2023. That's year on year. We also look at month on month to get a kind of nearer term look at, you know, the kind of direction of, you know, price changes. And so actually the big figure that I guess surprised everyone was at the core level and the month on month core reading was +0.3%, which was higher than what we were expecting at 0.2%. It's also the highest monthly increase at the core level since April. And so that was kind of almost flip the exact opposite of what that headline reading was talking about. And so everyone was like, oh, hang on a minute. Um, and I think what explains that big change in the chances of a 50-point cut, what explains that is because the meetings next week— I mean, there's no time left, right? And this inflation report is basically the last key piece of data, although we're going to get a bit of retail sales figures announced in about 60 seconds' time as I'm speaking. But that inflation report was the last key bit of data, right? And there's enough of a mixed bag in there for the Fed to go, whoa, hang on, let's just— let's not jump the gun here. And they'll play it cautiously and do a 25-point cut next week. So it's the proximity to the meeting which I think explains the large drop in expectations of a 50 cut.

And just a final point on this, I know something that was mentioned by analysts specifically was shelter prices. So I guess just for anyone new to the show and, and this general field, just explain to me like why— what is shelter prices and why is that so important when people like you are looking to determine the outcome of rates?

Well, inflation is a complex beast, and really it's trying to measure the— what rate are prices changing in the economic system? It's the cost of living, right? How quickly is the cost of living going up or down? All right, and that percentage measurement is that— that inflation figure is a percentage measurement of the rate of price change. Now, so what are the prices that are being measured, right? And it's like everything you could possibly imagine that you spend money on. You know, transport, food, you know, energy, all this kind of stuff. But then also one of the biggest components in the inflation basket is what's called shelter costs. In there is included rent, the cost of rent, okay. Now it's a really big component of the inflation basket, so when there's changes in shelter costs, that has an outsized influence on the headline inflation number, number one. Number two point, that's been the component of the inflation basket that has been stubbornly high. It's like the last big component of the basket to actually drop, and so people have been specifically focusing on that. Now, through the summer, it started to drop, and that's why we've started to see, you know, some, some decent numbers on the inflation side. But here in this report for August, it's just kicked back up. To be honest, it's actually really difficult to know why. It seems a bit of a weird one. I say that because when you look at actual rent prices— there's a couple of sources for this in the US, um, the two big sites are Zillow and Apartment List, okay, they're two big sites that track, you know, housing and rent costs and stuff— and they're not showing any uptick in rent costs at all in August. So it seems a bit weird then that the shelter cost figure's gone up. So it could be that this shelter cost inflation number, which has been volatile in the past, could be just a blip higher. And back in, uh, September of last year and then January of this year, the shelter cost number spiked up, and then the following month it spiked all the way back down. So I think because of those rent numbers off Zillow, it probably would appear like this is a temporary little blip and that we should get those shelter cost numbers back down again next month, I would predict.

So would I be right in my saying then that for you not a great deal has changed in terms of your, your rate outlook? But how would you explain in the intraday that type of price movement? I.e., let's just focus on stocks because it's the one that will probably make the most sense to, to people. Initially stocks fell quite aggressively and then they really ramped I think it was about an hour or two after, all the way into the close. And there were, there were names like Nvidia, which finished the session up about 8.5% after they had shed something like $300 billion a few days before. So, yeah. Is there any way of making sense of that, or is it just one of those things where let's not try and fit a narrative to a move?

Well, I think it's definitely one of those things where you wouldn't necessarily have expected predicted that outcome. Like, if you were told what the numbers were going to be in advance and you were like, right, I'm going to predict how the market might respond to this, I don't think many people would have arrived at the actual outcome of what markets did. Um, so, so therefore there is a— to a degree, there is— well, okay, I've got to curve fit this back and I'm trying to, as you say, trying to fit a narrative explaining something after the event with the, with the benefit of hindsight. But I want to take the NASDAQ here because obviously Nvidia, as you said, was the most volatile out of all of this. And the NASDAQ dropped sharply off the initial figures, as did the S&P and so on, right? And I think there it's interesting that— well, there I— there's two possible reasons why stocks had a knee-jerk move lower. Take your pick. They're actually quite opposite reasons. But number one is looking at that headline inflation number, which dropped sharply to 2.5%. And you might think, well, okay, great, the Fed might cut more, so isn't that good news for stocks? But at the moment, as we saw off the payrolls report, um, last week, bad news about the economy is seemingly feeding through to bad news for stocks. So if inflation's suddenly going to drop off sharply, then actually that's a further indication that we're losing economic momentum and there may well be a recession on the horizon. Okay, forget about the Fed and cutting. Maybe the Fed are too late. All right, so there's that kind of idea, right? That's number one, park that. There is another potential thesis which is, forget the headline reading, you're looking at that month-on-month core reading and that was higher than expected. So maybe there people are thinking, well, higher than expected, the Fed won't cut 50, Okay, that's bad news for stocks. I'm gonna sell. So there's your two theses. I, I don't care which camp you want to sit in, either one are valid, I would say. Then it all flipped entirely on its head. Now I can, again, hindsight trading here, but I can only think of one idea, which is that, you know, we've been talking through the summer where big tech there's been a, there's been a changing of the guard. And big tech, the Mag 7, that had been leading stock indices higher for 12 months, summer '23 through to summer '24, um, you know, led by Nvidia, okay, that narrative switched and there was a changing of the guard and the Mag 7 came off. There was profit taking in the Mag 7. We're approaching a rate-cutting cycle. This is going to benefit interest rate sensitive sectors that have been underperforming. So people were booking profit on their Mag 7 and buying other sectors or smaller cap companies. Okay, that's what's been happening for the last 3 months. It could be people have decided that that trade has now gone too far, or there, there's enough uncertainty about the speed of rate cuts that maybe they want to book a bit of profit. Which means they've got to reverse that by now, you know, selling some of those smaller caps or selling some of those other sectors and buying back your big tech, which has had a decent correction. So it could be that people are just thinking, well, hang on, inflation's still a bit sticky, you know, we've got uncertainty around the election, of course. So maybe there's just a bit of profit taking there. That, that's about as good as I've got, I'm afraid.

Yeah, I might need to get you a new job at Bloomberg or Reuters or something like that. You can come up with your, your new narrative.

There is one other theme I want to talk before we move on from inflation.

Sure.

Which is a bit more medium term, and it's really looking— I would say feeds probably into your rate-cutting expectations for 2025, because no one's really talked about that yet, which is surprising given we're, well, we're nearly into Quarter 4 almost, right? So it's only 3 months off and no one's really yet looked that far ahead. Maybe it's because the election and people just are a bit obsessed by that and that will come first. But I would say I want to talk about commodities, which is such a key component in inflation, um, and not just the price of oil, for example, which is a kind of direct price point that feeds into people's energy costs, but it's the price of products, right? So if inflation— like, if metals like copper and iron ore, which get used for manufacturers to build their products, well, the price changes there often take a little longer to feed through to the end consumer, right? And when you look at the commodity complex at the moment, it is getting hammered. Um, let's start with crude oil. I mean, that's— this week it's kind of broken down, new lows Well, we just broke a key level, which was the mid-December 2023 low. And actually, to be honest, we're basically— we're testing the March '23 low. We did tick below it slightly. Oil's basically the lowest it's been since autumn of 2021 now. Okay, that's really key. Obviously a big input cost for pretty much everyone on the planet. Go and have a look at your, your metals. So I mentioned copper. Copper's been selling off sharply since the spring. Copper peaked, it got above $5, it's now down to $4. So we've had a kind of 20% sell-off, um, in copper, for example.

Yeah, and just to say, copper is obviously a good metal specifically to look at given its properties in tied to manufacturing growth, infrastructure, kind of tied to China consumption, things like that.

Absolutely. Uh, let's take iron ore, exhibit number 3 here. That peaked in January '04 at $143. It's now trading $92. Big breakout below $100 just over the last month. And, and to put that into perspective, we got a really, really key level which was the October 2022 low around about $84. That's such an important technical level, and we're not far off it. We're almost certainly going to trend down and test that. So look, iron ore prices are really low. Go and have a look at your ags, um, like wheat, for example, which is a commodity price obviously that feeds through into things like bread, which is a critical food item for the world. Over the last few months, it's come down sharply. It has bounced a little bit, I will say, in the last 3 weeks. It's actually had a bit of a sharp bounce, but overall, it was above $700 in May It traded all the way down to $500 2 weeks ago. As I said, we bounced back up above $550 here at the moment. But point being, generally speaking, the commodity complex is down, down, down, and it's only a matter of time before that continues to feed through into deflationary pressures. And so I would say that you should expect, whilst the Fed aren't going to cut by 50 next week, um, and may not cut by that amount at all at any other meeting this year. I just think that it cements the idea that the interest rate cutting cycle will begin next week and it'll extend all the way through 2025, and who knows, probably beyond, right? So yeah, I think generally rates are on the way down for a sustained period.

Just for the purpose of people thinking about careers, so as you've described it, right now people seem to be overtly focused on the short term, the first cut, and the size of the first cut. Can you explain to me who are the participants working in and around, so whether it be sales traders, flow traders, these types of stirs traders in the short end of the curve out to then someone who's looking at the cycle. So how do you break that up so to inform young people who are thinking about—

it's a really good point. So there's lots of different what we call market participants. So who's buying, who's selling any of this stuff? Well, loads of different players who have got very different agendas and strategies and most importantly very different time horizons. So if you're looking short-term, if you've got a short-term time horizon, which on the buy side could be a hedge fund, could be like an algo trading, quant trading hedge fund that's looking to get in and out of trades. Well, if you think about high frequency, you know, we're talking about milli-microseconds kind of stuff. But then, you know, macro funds are often in and out of trades intraday, intra-week, intra-month, and are looking to really take advantage of that very short-term macro news-driven volatility. Okay, they're in and out, and, and the volume from those players has been steadily rising over my career, over the last 20 years, of course, as algos have become a much bigger part of the, the market structure. So you get these big wild swings. Good example, the inflation data yesterday— big swings as you got those short-term players, you know, getting stuck in and trying to make sense and take advantage. But you kind of— and then on the sell side, fine, who's servicing those buy-side clients, you know? So your key, you know, sales traders and market makers at investment banks, it's the big brokers that are helping to facilitate these trades, you know, they're obviously in the mix. Now let's go to the opposite end of the spectrum, you know, your big asset managers or your value investors. Let's take Warren Buffett as an extreme example, you You know, is he messing about here every time there's an inflation date print or every time Powell speaks or every time there's an on-farm payrolls number? No.

He wouldn't have lived for so long and be so healthy in mind if he was getting involved in this intraday shenanigans.

So look, he doesn't care so much about the noise, which is exactly what this is, right? It's just noise. What he cares about is the change in rate hiking cycle. And so, you know, when you look at US interest rates, um, well, we're at 5.5% and we got there in July 2023. Takashi, that's quite an interesting point. Rates in the US peaked 14 months ago now. It's a long time, right? So we've been flat at 5.5% for 14 months. And it's just been about picking the timing of when the rate-cutting cycle is going to start. And for sure, I mean, I would say it's close to 100% guaranteed, it's next week. It's on the 18th of September next week, right? So that's when the rate-cutting cycle begins. Buffett's already got this. He's already priced it in. And for him, it's about not, not necessarily when it's going to begin per se, It's really the rate of, or the speed of decline, and over how long. So we're at 5.5%, how long is it going to take to get the, to get the rate down to 4? Is it going to go down to 3? You know, where's the bottom of the rate cutting cycle next time round? These are the questions that Buffett's probably toying with to then make major kind of wholesale changes to his strategy, which he has been doing throughout the last 6 months, right? He's he's been coming out of some of these bigger positions like Apple, and he's got a huge cash pile. And I think that's because he's waiting for this change in cycle to then like look to, you know, pick up on some, you know, discounted value plays, uh, some of these markets come off.