Ep.53: Will The Fed Hike 50bps As US Inflation Surges

Okay, hello and welcome to episode 53 of the Market Maker podcast. I am joined by co-founder and head of trading Piers Curran, as ever, as we delve into some of the major news stories of the week. But before we begin, we have a big announcement to make, and Piers, I'll let you take the stage. Yeah, as the older statesman.

Hang on, um Yeah, well, I've been running this company for 13 years, and I would say the most important thing that has ever happened to this company has just happened this week. And that is, we've just agreed a partnership with Morgan Stanley. And this isn't any old partnership. This is massive. And this is all about you know, it's a huge endorsement for our big mission with AmplifyMe. And our big mission with AmplifyMe is about, you know, disrupting recruitment in finance, disrupting and, you know, democratizing opportunities, you know. And what does that mean? Because that sounds a bit like something the marketers would come up with, but basically level the playing field. Let's make it more fair for people to get jobs at top banks. And not only that, let's help banks find super hot talent from a much wider pool, much more diverse pool of candidates. And, you know, for years the recruitment system at banks has been failing the masses because they've only been recruiting the elite. The elite academics, let's say, from the top universities who are generally more privileged in terms of their background, and it's an unfair playing field. And we built AmplifyMe, which is a— and our finance accelerator simulation in order to try and address this global problem. We set out our mission to make this simulation available for free to everyone on the planet who wants to take it. Anybody, anywhere, um, who would like to start a career in finance, come and do our simulation. Because it's our belief that banks should be hiring people that have the potential to do the role really well. For too long, banks have been hiring people because of their CV. Because, I don't know, they've got 3 A's at A-level and they've gone to Cambridge, or, you know, that their dad knows someone high up at Goldman's. You know, that's, that's how it's been, right? And it's time to stop. And AmplifyMe is our mission. And Morgan Stanley have just come in and said, right, we want a piece of that. We absolutely love this mission, and more than that, we are going to back it to the full and we are now going to be spearheading Morgan Stanley's recruitment for their sales and trading division for the whole of EMEA, the whole of the Americas, and the whole of APAC. Um, and it's a massive deal for properly allowing us to achieve our end goal of getting really talented people into these seats on the trading floor at Morgan Stanley, people who have got what it takes to do those jobs. And there's only one way to measure whether they've got what it takes, and it's not by looking at their CV. And it is not by interviewing them even. It's actually by putting them in the seat and watching them perform. And only then can you see. And this is what our simulation is— financial— sorry, Finance Accelerator sim. We put you in the seat and you do the role and we're measuring how well you do it. We're measuring it in a whole bunch of different ways, loads of metrics that comes out of this, performance metrics. And it's these metrics that tell you, are you any good at this? And actually, which parts of the role are you good at? And what are your skill sets? And what types of roles are best suited to those? So that it can help you, the individual student, figure out your, your optimal career path. But then even better, if you perform well, we're saying to Morgan Stanley, check this person out, they are super talented, and this is a pathway to now get hired by Morgan Stanley by doing our simulation. So yeah, I want to say thank you to Morgan Stanley for— we've been working with them for years, but in terms of helping them train up their staff for life on the trading floor and helping them with campus recruitment events and stuff. But this, this, this takes it to a 100 times different level where they're entirely backing us to find them talent all over the world.

Yeah, when we launched this Amplify Me mission kind of officially in September of last year, we did do an episode called In Search of Serena kind of a play on Serena Williams, just, you know, coming from an untraditional background and literally becoming the greatest tennis player of all time. And that is kind of a good analogy that we like to use in terms of that talent and potential and unearthing those incredible hidden gems out there. And so, um, really would love for everyone to just go on to your podcast platform, Spotify, Apple, if you go back down, we're on episode 53 now. If you go back down to episode 33, segmented between 33 and 34 is Amplify Me In Search of Serena episode. Go back, check that one out. And, you know, I'd love for you to listen and be part of this, this ambition, this mission, this community, because I think, you know, it's going to require everyone's help and input to really spread this. And get it out to as many people as possible.

So yeah, and I'd say any students listening to this, and I know there's lots, um, Morgan Stanley have just helped us smash down the barriers. So it doesn't matter where you are, what you're studying, if you fancy a shot at working for one of the big guns, and Morgan Stanley are literally, well, as obviously you'll know, one of the absolute big guns. If you want a shot at working for Morgan Stanley, come and do our simulation. It's free. It's online. Go to AmplifyMe.com and just get involved.

You never know. Cool. All right. Well, look, on a slightly more serious note, I need to clear up a bit of a miscommunication on my side from the last episode. Because anyone who did listen to the last episode will know that I made a commitment to shave my head live during one of our podcasts. And obviously it's recorded by Zoom, and then we would put that out as per normal. I think I got a little bit excited.

As Mrs. Cheung, how did it work?

No, not at all, actually. I've had a whole bunch of people email me, tweet me, even say to me— well, I've been in the office this week they are actively not going to rate our show because they want to see me shave my head. So I just like to reverse my communication. I'll commit to shaving my head, I'll commit to that. But yeah, the target needs to be hit, guys. Come on, it's not the other way around.

So hang on, let's properly clear this up. What's the target? And if that's reached, you'll shave your head. What was the number?

Guys, it's got to be big because that's, that's a— it's not going to go down well with the missus, as you say. I'm going to put— well, you, you've got the target of what we've got to hit, 250, was it, or 350? You upped the ante, didn't you, by end of Q1?

Yeah.

Okay, and you've got £100 on the line. Yeah. Uh, if we get to 500, I shave my head.

All right. That is— are you able to do it more than once?

If we hit 1,000, I do the eyebrows, I do the full— I just go full on.

I suggest you stop talking.

All right, well, let's get to it then. There's been plenty going on this week, namely US inflation and Fed thinking about interest rates. We're going to delve into that much deeper, but let's just have a quick summarize of some of the major headlines. Peloton still in the news. They announced in the early part of the week on Tuesday they plan to replace their CEO, John Foley. I don't know if you saw that slide pack that came out. Was it Blackwell? I think it was one of the investors. I think they own a small share, like less than 5%, but they put out— they'd be trying to oust Foley for ages. And it was the most damning, like, 10 or 12 slides in this deck that you've ever seen.

I didn't see that.

I think Eddie, our colleague Eddie, if you don't follow Eddie Donmez on LinkedIn, you should. He puts out awesome material on a daily basis, and he shared that deck. If you want to laugh this weekend, you should check that out. But essentially, Peloton are going to replace him. They're going to cut 2,800 jobs, about 20% of the workforce. Barry McCarthy, the former CFO of Spotify and Netflix, will become the CEO and president actually on, on Peloton's board. The other big stocks news, two others I want to touch on. SoftBank's $66 billion sale of UK-based chip business Arm to Nvidia collapsed, and right, right on the beginning of the week, late on Monday, after regulators in the US, UK, EU raised serious concerns about its effects on competition in the global semiconductor industry. That was going to be lined up as the largest ever deal in the chip sector. But I know there's a couple of interesting points on the back of this about what happens next, right?

Well, yeah. And on that, just to cut— just on the regulators putting their foot down on that one, in terms of market share then, So Arm shipped about 500 million of these chips. Well, they've shipped 500 million— sorry, that's since 2013, right? And that puts them at 18% market share globally. Nvidia— this is who the deal was going to be with— they have a 20% market share. So this would have put them at a 38% market share. The problem being— that Intel have a 62% market share. So basically, if they'd have led this deal through, you've basically then you're down to 2 companies pretty much owning the planet's market share. So this is why inevitably— I find it a bit weird that SoftBank tried to go down that path because they're in the hole for a big bill. I think, to pay Nvidia for this deal not going through. So I can't see why they attempted it, given that it seems so straight up, obviously, not going to be allowable. And it becomes very political, obviously, when you've got a UK company, Arm, and obviously then the US company Nvidia. But anyway, the next plan then was, okay, We can't sell to NVIDIA. Fine, let's try and do an IPO. So SoftBank have been exploring IPOing Arm this week as an alternative direction. But this has now brought to light something that's been bubbling away for 18 months plus, which is there just so happens to be a massive standoff internally within Arm between Arm and the guy who runs the China branch. Okay, so there's this guy called Allen Wu who has been heading up the China branch of Arm and is a, you know, decent-sized shareholder. It's got a bit complicated in some of the share structures that this guy has set up within China, which has made it incredibly complicated, but just try and try and roughly simplify it, this guy owns about 15% of the Chinese arm of Arm. And the Chinese arm makes up about 1/7 of Arm's overall revenue. OK. The problem is this guy's a bit of a liability, it turns out. And he's been doing stuff that the management HQ have not been liking. And in June 2020, they tried to get rid of him. So the board voted to oust him, and he refused to go anywhere and has been counter-suing. And ever since then— and I, I've never even heard of this story, and it's only now when Arm kind of hits the news that it all kind of comes to the surface— but basically, um, there's been a standoff since June 2020, and they've been trying to get rid of it. And some serious stuff's been going on. So this guy over in China, Allen Wu, At one point, he hired a security team to deny ARM representatives entry into the Shanghai offices. He also installed an email filtering system to block headquarters messages reaching his staff in China. I mean, it's like a dictator takeover here. But the problem is they can't IPO whilst this kind of baggage is left unresolved. So now I guess Allen Wu's got even more leverage now, right? So SoftBank have got— you know, this Arm deal for them has been amazing on paper in terms of the value of that business, and they're sitting on, you know, many billions worth of profit at SoftBank, but that's paper profit. But trying to exit this trade is proving to be a nightmare, and they've tried one route, got blocked by the regulators. They're trying another route, and Alan Wu's coming in and scuppering it. So yeah, it's going to be an interesting story to follow and see. I don't know, is there a Plan C? I don't know. Or they're just going to have to pay up big time to Alan Wu to get him out of the way.

Yeah, I think, I think Wu's in for a big payday.

Yeah, woo-hoo!

Always comes down to money at the end.

Indeed.

So moving to the final stocks conversation. Facebook— sorry, Meta Platforms, I should say. They now trade at a P/E ratio of 16. It came to light now this week. I think their shares earlier in the week were down about 30% from where they were prior to the catastrophic drop on the back of their earnings and outlook and everything else in between. But it's the lowest P/E ratio for the company in its history. And as a comparison, the PE ratios for the other big tech companies is as follows: Google, or Alphabet, 25, Apple 28, Microsoft 32, Amazon 49.

Yeah.

So any feelings about that?

What—

when you hear that, what do you think?

I think it's a great headline, is what I think. I think it's like when you can write— if you're writing an article and you can put at the top Facebook's lowest ever PE ratio in its entire history, that's like, wow, sensationalist, right? I want to read this because what the hell's going on? Well, firstly, a PE ratio, that's price-to-earnings ratio, is arguably the most common multiple that gets thrown around when you're valuing a business. It's, you know, how valuable is the business relative to the profits that it makes. So when we say 16 times, that means currently the value of Facebook according to the share price, by the way. So the market cap is the share price multiplied by the shares in issuance. So the share price of public companies listed on stock exchanges always enables us to pinpoint a value of that entire business at any moment. You just look at the share price and that's right, we can get the market cap. We know the profits of of these businesses because by law they have to be reporting their earnings once a quarter. So we can always keep an eye on the price-to-earnings ratio, okay? So 16 times, they're trading at 16 times earnings, and that's the lowest they've ever had. And I know that sounds pretty wildly sensational, but really it's the lowest they've ever had because, well, their share price has just dropped by 30%. OK, fine. So if all you did in life as an investor was make decisions based on PE ratios, then fine. I would say that you might argue more often than not, it's not a bad rough rule of thumb, and you'll probably do OK if you buy low when PE ratios are low, when valuations are cheap. If you buy and then if you sell them when valuations are expensive, well, fine. You're probably going to do okay. But that's kind of just generalizing. You have to look at each individual company. You can't just blindly go in and go, oh wow, 16 times, wow, that's so cheap, that's the cheapest ever. It's literally the best time to buy Facebook shares. Except that— well, hang on a minute. For all the arguments we put forward on the podcast last week, it's this low in value for a reason. And just because it's got a low valuation doesn't mean it's cheap. Based on its potential going forwards. And so not only is the share price dropped, which has meant that the PE ratio drops, but also, you know, their profitability arguably is going to maybe drop in the years ahead as their cost base increases on the Meta side, and maybe as the advertising revenue starts to get eroded with users moving away. So I wouldn't be buying Facebook because the P/E ratio is the lowest it's ever been. Now when you compare it to the others, you've got to be a little bit careful here as well. So Google on 25 times, and by the way, the S&P 500, the average is 25 times at the moment, which is by the way relatively very high in terms of historical standards. But Google's at 25 times, Apple 28, Microsoft 32, Amazon 49. It always sounds like Amazon's just way off into the stratosphere, and therefore it implies that Amazon's more expensive if their PE multiple's higher, right? They're trading at a higher multiple, more expensive. Except you've got to understand these businesses and what they do. And Amazon, well, A, is a very low margin business, but that's a side point. Amazon have a strategy of plowing back all their profits into building out the goliath of the infrastructure of their kind of warehousing across the planet. So they've always been plowed back in, which means their profits are relatively low. And if you've got low profit, well, then this is good for your PE ratio, right? And so— well, not good, sorry. That means your PE ratio is higher. Um, but Amazon trade at an artificially higher multiple compared to the others because of the real— the kind of strategy of how they run their business.

Cool. Well, that was an excellent explanation. So I hope that kind of deconstructs it into a much more manageable way. And tying in with our first company, Peloton, Amazon of course said to be sniffing around.

Yeah.

Which makes, I guess, quite a bit of sense. I think there's been Nike and Apple, the other two. It'll be interesting to see how that plays out, given Amazon to broaden in that kind of fitness and wellness kind of segment of the, of the market.

But, um, yeah, and obviously one of the issues Peloton have had is their distribution logistics. Obviously they've got a physical product that they've got to get to the customer's front door, and that's been a real pain during COVID obviously, and all the supply chain issues. Obviously Amazon could immediately address and remove that problem entirely from the company. And obviously Amazon also, maybe you probably say, uh, probably behind the race on the whole health space compared to the other big tech firms. So yeah, it could be a way for them to jump in, but Again, on that headline we were talking about it, the share price— Peloton share price rallied off the back of that Amazon rumor. Um, I think it went up— was it like—

it was in the foot— it went up 45% or so when it first broke.

Yeah, right, which again sounds unbelievable, right? Sounds like a massive rally, and it is in percentage terms, but you've got to understand that If something rallies off an incredibly low base, then it doesn't take much for the percentage change to start looking massive. And to put it into context, it rallied from $24 to, let's call it, $37, right? It rallied from $24 to $37, okay? In September last year, it was trading at $115. So this is what I mean. When a share price collapses, percentage changes can become massive when actually in dollar terms, the dollar value change is actually relatively small compared to the historic price. So yeah, it's one to monitor.

Yeah. All right. Well, look, let's have a quick look in commodities and geopolitics and then we'll get straight onto the Fed. And so in terms of other asset classes and products, oil is headed for its first weekly loss since mid-December, flurry of diplomacy increased the chance of an Iranian nuclear deal being revived. But you got to look at the price as well. We've rallied to a 7-year high. And actually, if you look at the WTI, which is West Texas Intermediate US oil chart, we're at a point of technical resistance on a much higher timeframe. So I think it makes sense just anyway for the price gains to have a bit of a breather. And then the other thing to touch on is this whole ongoing Russian-Ukraine situation. The latest being this week, French President Macron went to visit Putin. He tends to be the frontman for European business on these matters. And yeah, Macron's trying to unify, I'd say converge forces of Europe to have a collective front which is the right strategy, I guess, in these— in this type of situation. Interestingly then, where I want to take this is immediately upon leaving speaking to Putin, he went to go and meet the German Chancellor. And it's always the same, whether it's Brexit, whether it's the threat of gas and energy supply to Europe, the heart of Europe really is determined by Germany and France. And in that respect. And while those two countries are trying to, as I said, unify Europe, Biden over the Atlantic is chiming in saying he's just going to cancel, he's going to tear up the Nord Stream 2. I'm going to— he deployed more troops in certain regions, which again is a more provocative move that starts to increase tensions at this point. So for Biden then, Surely this is only going to be harmful for his relationship with, with Europe by taking such action, given the fact that Europe is so dependent, as we know, on the energy supply coming from that region.

Yeah, but he's got bigger problems, so he can throw his European mates under the bus because in the end he's Well, he's got big problems at home in terms of his ratings. And you've got midterms— well, now are— well, what are they, 9 months away now? You know, that, that kind of clock is ticking down. And as of yet, he's not been able to reverse the trend in terms of his ratings. And so he's getting— he's going to get more desperate as the months go on. And, you know, this is another signal of that. So it's very much about trying to play the strongman. It's almost like trying to be the Trump, ironically. He's trying to play the Trump card.

Well, particularly with the messy withdrawal from Afghanistan, he has to reassert himself on that foreign front.

Yeah, and whilst what he says— what he's saying about— well, not only saying more troops as well, but it's not going to help matters, it's going to make them worse. And obviously Europe are in a much more tricky situation with Russia than the US are. It's fine, the US kind of shouting in their megaphone from the other side of the Atlantic, but when, you know, Europe is so dependent on Russia for oil and gas, it's a much more— it's just a bit of a political minefield. And so you can't be aggressive with Russia certainly with Putin, right? Because, you know, in the end it's going to come back and hit you in the face, I think. So yeah, I think Biden is playing his own agenda and it's all about domestic politics in the US, and it's a risk because, as I said, I think he's going to get— he's going to have to get more and more desperate.

Right. And on that front, this week the Biden administration said they're considering new Chinese tariff probe because of data that's shown a shortfall in China's commitment to increase US purchases. And so he's now putting the gas on China as well. At the same time, all of this is obviously happening. And of course, to lead us into— there's this other small problem that inflation in America just hit 7.5%, the highest since 1982. Now, before we get onto the monetary policy side of things, politically, I mean, this is the worst-case scenario for him, right?

It is. And unfortunately, it's out of his control. And that's the hardest thing. He'll still get blamed for it, though. And I guess he's kind of between the rock and a hard place on that. But in terms of how people in America— why might they be annoyed about this. And there were some interesting stats that came forth because obviously everyone talks about this inflation thing. Oh my God, it's 7.5%. I'm fine, they're just numbers. It's hard to kind of, you know, properly understand what does that mean actually for someone living? What does it mean for a household in the US? And actually what it means is the numbers that have come forward just this week is that on average, the US household is having to spend $276 more per month on their goods because of inflation. So they're $276 per month worse off. So that's what high inflation actually means. It means $276. Now, when you think about it, on the one hand, you might think, well, that's— a lot of money, right? And especially when you go down to the lower income categories, which by the way are— it's like the engine room of the consumption economy. And that's a massive amount of money, by the way, $276. And when you think about, well, okay, that's per household. There's 130 million households in America. So actually, that's $36 billion. Per month worse off because of inflation. So when you put the numbers like that, you start to understand, okay, right, well, this is a problem for Biden because people are having— they're way worse off and they're angry about it. And obviously, who do you blame? Well, you blame the people in charge. And whilst it might not be fair to go to Biden, oi, you're completely mismanaging the entire economy, get out. That's unfair. But from their point of view, that's what they think.

Well, I know what advice Donald Trump would give. It's the Chinese. It's the imported costs coming from the Chinese who are charging too much for their goods. We need to unite as a country, become one, and defend against these we are becoming— making us victims of their inflation problem. And then that's the pivot, the optics. But the problem is that Biden can't do that, not to that length, because it's too out of kilter of people will not buy that from him.

Yeah.

And so, yeah, that's why it is more complicated. That's why I think characters who buy themselves room for maneuver in whatever shape or form that might be, like Boris Johnson, for example, you can get away with things that perhaps other politicians couldn't, or say things that others might not even dream of. But it's a very interesting point. Um, but look, I mean, that, that takes us then into the discussion of the monetary policy side, and that's the side, I guess, that yes, Biden, uh, definitely that, that whole conversation is important. But for now, what the markets are trying to digest is the Fed have got to act, and it is how do they act. And we've talked about this a lot. We've been slightly surprised here about how they have pivoted very quickly to a more hawkish path forward in terms of the sequence of events to tighten policy. But now the market is pricing 90% probability of a 50 basis point rise in interest rates at the next meeting. I think it's 33 days, so right beginning of March. 50 basis points is now almost 100% priced in that that will happen. Now, one thing I would like to say on that point is, I guess, a bit of context. For one, the last 50 basis point move, uh, May of 2000, That's when they increased 50 basis points. Prior to that, there was a 50 and a 75 basis point move, 1994 to 1995, during that hike cycle. The one, uh, common thing between those two rate hike cycles was actually the rate hike of 50 came either at the end of the cycle, right, or in the middle of the cycle, not at the beginning of the cycle. Now, I think now the pandemic, the cause of the inflation and the way it's emerged, I think it's all well and good making those statistics and putting them out there. I don't actually think they're appropriate for the conversation of now. And for one, Fed Chair Powell himself explicitly said just the other week that the current environment is different from the past. So he knew everyone was going to jump to these conclusions. And so he's trying to already front run that. Now, from the Fed's perspective, the market's always going to be more agile to move. I mean, yesterday's number comes out, market pricing changes immediate, and the dust settles, and we see whether it resides at that initial assumption price. And so we'll be interested to see in the coming days whether or not we still remain that heavily priced in. But as far as Fed speakers are concerned, they're much less committed so far, at least in their communication, about this notion of 50 basis points. So to give you a couple, uh, Mary Daly, she said a half-point rate hike is not my preference. Barkin said, I'm open to it conceptually. Do I think there's a screaming need to do it right now? I'm not convinced of that. However, on counter to that, and unsurprisingly because he's the uber hawk, but he is a voting member of the FOMC this year, James Bullard, he said that he favors 3 hikes by July with one of them being a half-point move. And one of the banks that has agreed with them, and a quite infamous strategist on the street, Jim Reid at Deutsche Bank, has also said he thinks 50 basis point move in March. That's their base case that they're going for as well. So where do you sit on this this 50 discussion?

Well, now you've said Jim Reid thinks 50, I'm going to— I'm slightly less confident about my stance. My stance is not that. My stance is 25. My stance is that I think the market's just overreacting now on the hawkish side, right? We were— last year was all about we were overplaying on the dovish side, and I think now we're overplaying on the hawkish side. And I just think that it's not as bad as the sensational headlines read. That's not how markets behaved. Like, you know, that's a massive move. So I do want to talk about bond yields and bond yield moves in response to the inflation data yesterday, which definitely tells you the picture that people are alarmed and they're thinking 50 basis points. And I think it's an overreaction. We'll find out.

Just on this point, CNBC, as we're recording, have just put out a piece entitled Several Fed Officials, Both Privately and Publicly, are pushing back against Fed's Bullard's 50 basis point rate hike. Instead, CNBC says— so when CNBC or any financial news media company uses this language, it's a source. So someone familiar with the thinking at the Fed, i.e., someone at the Fed, is obviously quite shocked by the assumptions the market has made. And rather than officially communicate it, they're using the avenue of using a media agency CNBC also adds that it suggests the central bank is likely to embark initially on a more measured path. So a little bit more controlled in that sense.

I think the way the market— I think where they've got confused, I think it is true to say that if the Fed didn't have a QE program that they had to wind down, or they think they've got to wind down first, before being able to hike. I think if they didn't have that program, they'd have hiked already. They'd have hiked at the end of last year like the Bank of England did. And maybe we'd have already had a second hike or so. But I think the point— and historically, and again, because of how— and it's the Fed's fault— because of how over the years markets have become so sensitive So the minute detail of what the Fed communicate, we hang off their every word. What they say does matter because prices move off them, and therefore that's why it matters, because it has a big impact on people's wealth, it has a big impact on people's portfolios and investments, right? So the problem is that they've become too hawkish. Well, that's The problem is that the Fed had to be tippy-toe to start with, at least slow down the stimulus program first before then we start hiking. That's what we've done in the past. We've had to do that in the past because we don't want to freak people out and markets go crazy. So we got to go slowly. And because of that, they're getting further and further and further behind the inflation curve. They should have hiked end of last year, right? But we would have all freaked out and panicked. So they're kind of— they're a victim of their own— the situation, they've— this negative feedback loop that they've created between themselves and markets. But anyway, so that's why people are thinking, well, they've got to catch up now with a 50 hike. I just think people are overexaggerating. We'll talk about the inflation basket in a minute, but just in terms of market reactions, I guess again, there's so many different markets you can look at and so many different price reactions, but obviously if you want to choose the most sensational, there was a guy from Reuters that tweeted a chart that was looking at the 2-year— so the US 2-year government bond yield. So when we talk about interest rates and we talk about bonds, so obviously with bonds you've got lots of different durations, right? Put it more simply, different lengths of loans. The time period of the loan is longer or shorter. So we talk about short end, talking about 1 or 2-year loans essentially, so 1 or 2-year duration bonds and the yield on those bonds, right? Now when we talk about central bank interest rates, basically the central bank interest rate is simply a reference rate for banks to use when they're lending money over about a 2-year period. So a 2-year bond yield is the most sensitive to interest rate changes. Out of all of the bond durations, it's the shorter end that's most sensitive because that's the— that's what the central bank's interest rate is for, short-term loans, right? So it's always going to move the most, the 2-year, but actually the 2-year bond on Thursday moved from pricing in one hike in March to basically almost fully pricing in two hikes, which just means the yield went up by almost 25 basis points. Now, for the 2-year bond, that's a phenomenal move. These short-end bonds, the prices, they're super stable. The volatility is the lowest you could possibly imagine. So for it to move sharply is very unusual. And, um, the guy from Reuters showed a chart looking at, um, a single-day move based on the average price movement over the previous 12 months and using standard deviation. And basically, from a— it moved to above 2 standard deviations away. And from a standard deviation measure, um, it's the biggest move in the 2-year bond since October 1979. And in October 1979, um, there was a guy called Volcker, who I'm sure some will know about. He shocked the market by putting through a mid-meeting rate hike. So he hiked rates without waiting for one of the scheduled meetings. It was such an emergency, he just bang just did it. And that, that's the last time you saw the 2-year bond move so sharply relative to the movement over the previous 12 months, right? So look, this is a big deal for markets, and you had movement on yields. Yields moved higher across the curve, so the 10-year yield moved up and very significantly moved above 2%, um, which is definitely a notable situation. And here, this is where it starts to feed negatively into equities. One of the reasons stocks have been so high for so long and so bullish is that yields on other assets like bonds have been so low. So it's been forcing people to not invest in bonds and take more risk and buy stocks. That's been one of the catalysts for the giant stock market rally in the US over the years. So when the 10-year sneaks back above 2%, it's notable, and people start to look at that again. And it's potentially a moment— well, 2% still historically incredibly low, but in the short term, that's negative for stocks, which is why stocks came off sharply on Thursday after the inflation news as well.

So you're like what the analysts at RBC put out as a note this morning. They said, quote, the current pricing is close enough to the hawkish extreme of likely outcomes that the risk-reward of fading is just too attractive to pass up.

Right.

So yeah, it'd be interesting to see. The thing was is that I've been— obviously I'm here at my screens all day and the murmuring on Twitter has been— and the different sources of stuff that I look at and I aggregate— the amount of traders trying to coin an interbank hike, an interbank inter-meeting meeting, if you like, to then drop in an extra hike. Yeah, they're just getting too carried away, I think.

They do have 7 more meetings this year. March, May, June, July, September, November, December.

I think— I mean, you look, you tell me, you, you're the trader, right? And you've been around these people long enough. When you see the type of standard deviation you've just mentioned, you know what it was like on the trading floor, right? All the guys and girls get super excited, they're all wet at the whistle thinking, oh, wouldn't it be amazing if they just come in and drop in like a surprise hike right now? That would be brilliant as a short day, short-term trader. I mean, is that where you get these kind of like rumor-mongering come from? It's almost like the anticipation that was like what they want, and they lose the rational thought of actually what could happen.

Lose the rational thoughts. So you get whipped up into this frenzy of, oh my God, it'd be amazing. God, if that happened and I got the trade right, how much money could I make? Oh my God. Wouldn't that be an amazing trade? And then all of a sudden you've convinced yourself it's actually going to happen. And it's very irrational, of course. And I think we are, to a degree, I think we're in that situation. The only thing is, because the Fed— I think now, as of February, the Fed wished they could have hiked already. Okay, they wish they could have hiked already. They haven't, they haven't been able to if they wanted to stick to their format of not hiking until they've ended QE. They wished they could have hiked already. That's the only snag, doubt in my mind, is do they want to make up for the hike that they should have done already but also then do the hike that they want to do now as well. That's where you get your double hike from. But look, you've got 7 meetings this year, so fine, hike in all 7 if you want, but just don't do a double hike in one.

Well, look, I mean, if, if Jim's made you feel a bit nervous at Deutsche, Jan at Goldman's, the chief economist, will— is going to bail you out because Goldman's have gone from basically 3 to 5 to last night, 7 hikes now, and they see a longer series of 25 basis point rate hikes at every meeting commencing in March. So that, that, that's who you're joined by on that view.

Yeah, I, I think that's too hawkish as well. I can't see the Fed hiking 7 times. Can we—

let's—

can we just very briefly— I know it's a bit dull But can we just lift the lid on this inflation basket? So there's a really interesting article, you sent it to me actually. There's a good guy in the FT and his articles, his kind of column, it's called Unhedged, a guy called Robert Armstrong. Because some of his stuff's really good. I like his style. He's a bit more casual. He's a bit more anti-establishment. He's a bit more— I'm an outsider looking in and pointing at how ridiculous some of this stuff is in the financial world. It's kind of that. Sometimes I like that. I mean, I don't agree with everything he says, but he wrote a good piece and he was kind of just drilling into the inflation thing. And whilst fine, on the headline, the year-on-year inflation was 7.5%, which was higher than the expected 7.2%, and fine, is the highest for whatever, decades and crisis and alarm bells. But when you start to delve into the different components of inflation, and if you look at— so he did— I don't think it was his study, actually. I think it was the Bureau of Labor Statistics that did a study looking at core inflation first. So that's stripping out energy and food. Okay, so one of the reasons that headline 7.5% is so high is because energy, of course, of course, land food prices have been high, so take that out. But then you split what's left into 3 categories: durable goods, non-durable goods ex-food, and then services. Okay, so, and what he's looking at is actually a lot of these categories are declining. So if you look at durable goods, they dropped in the month of January. Well, they didn't drop, prices did not drop, sorry, the inflation rate dropped, which means prices of durable goods went up by a smaller amount in January than they did in December. Okay, so it's dampening inflation, which is good. Non-durable goods, they're actually on a 4-month downtrend now in terms of the rate at which prices are rising. So this is actually, when you look at those components, this is actually really good. If you're wanting inflation, if this, if you're wanting the inflation pressure to cool off, this is, these are good signals. But there's a reason to explain this, because obviously during the pandemic we were buying goods online, right? And so you might think, well, the durable goods and the non-durable goods, the reasons why prices, price rises are kind of calming down is because we've unlocked. And so, right, we're not we're now going out and spending money on services. I don't know, haircuts and going to get your nails done and whatever, right? So one negative thing, and perhaps why the market kind of panicked a little bit, was because the non— or the stickier sort of services prices. So the Atlanta Fed index— sorry, the Atlanta Fed, which is one of the federal Reserve Districts, they have this index which is called their sticky price index. This is looking at things like rents. If you think about your rent, that's a super sticky price. It's only going to change when your contract's up and I've got to renegotiate. But actually, so one thing we look at on inflation, and one thing people are worried about from the report from yesterday, is that some of these sticky prices have actually started to tick higher. And that's your concern if you're in the camp that the Fed are going to be super hawkish and they're going to have to hike 7 times or they're going to have to hike 50 in March. It's because your opinion is that the volatility of all the pandemic and how it's disrupted supply chains and fed into lots of price bubbles and stuff, your opinion is that that has moved on to feeding into sticky prices now rising. Rents and stuff like that. But if you take everything else, it looks like it's going to start to calm down. So the question mark comes around the sticky price feed-through. And is that— and it went up in January, and will it continue to go up February, March, April? And okay, if it does, well, fine, we've got a more sustained high inflation period that, yes, the Fed are too behind and they've got to accelerate. But otherwise, some of these other compartments of the inflation calculation are actually starting to show signs of cooling down, which is why I think the Fed will go 25 in March, which is why I think markets are now over-panicking about inflation.

Yeah, I'm just looking at the US equity charts at the moment. The actual reaction between now, Friday we're recording this, and CPI which came out the day before, really we're not far back to where we were prior to this number coming out. Because don't forget, we had already declined a sizable amount in January overall. So from a US equity perspective, I would be listening to this thinking, oh my goodness, how much are stocks down then? The point is, is that they're already down. The market had already dramatically shifted to this view. And this just cemented it in a way short term. And then it's got that, as you said, that whipping up of a storm because then everywhere you look yesterday, today, it's like inflation, the Fed are going to have to act and everyone on Bloomberg TV is talking about it. And you just get caught in the drama a little bit. What's interesting is yesterday, Last night I looked at the CME FedWatch tool, it was at 95%. It's already cooled off to 88% at the moment. So it's in flux at the moment. And given that CNBC kind of source comment, I would have thought by the end of today it will drop further. I mean, well, look, I just refreshed it now. Do you know what it's at now from 95% yesterday?

Uh, 85.

64.

Wow. So that's the probability of a 50 hike, right?

Has gone from 95% last night. It went, um, it was favoring— it was pretty much split before. It's gone up to 95, it's come back to 63. Yeah. Um, I think it goes lower still.

That sums it up. And I guess last week I was talking about how I'm still a little bit cautious and maybe this whole stock market sell-off Maybe it's not over yet. And, you know, I was kind of saying I'm reluctant to be in the buy the dip camp. And the reason for that opinion last week was because of exactly what's happened in the inflation numbers higher than expected and understanding how markets would behave towards that, right? But there is a tipping point on that sentiment. But when the market realizes they've overreacted. Well, fine, that's then the bottom, if you like, when the market realizes they've overreacted. Last week, I thought they hadn't realized that yet, and another high inflation print would again send a bit of panic. But maybe this is more of the turning point. I guess until we get— obviously, I think what's key is the Fed's meeting in March. Let me just get the date. It's actually the 15th of March, right? So that means we will get the— I'll just double-check this.

There's one more, I think.

We'll get another inflation data. We'll get the February inflation data announced in mid-March before the Fed's meeting. So that's your kind of one final kind of piece of information, and that'll be critical. But we've got to wait another month for that.

Yeah. And just look, for completeness' sake, with the other central banks, because they have been active in their communication as well this week. The chief economist at the Bank of England, Hugh Pill, he pushed back against aggressive pricing. The UK rates market has been moving in a similar fashion, just getting very bullish on rates. And he said 1% is not a trigger It's a point of consideration. And what he's referring to here is a reference point for the market's assumption of active gilt sales when rates eventually hit 1%. So he's talking about that sequencing on the next then trigger of policy tightening away from just singly rates moving. So he pushed back against that. And that came obviously as everyone was getting excited just the other week or so about the 5-4 split, because they wanted to go 50 the fall. So that's kind of cooled off a bit. And then Christine Lagarde, we know Europe's kind of lagging in this tightening race. But last week we had the ECB meeting. She didn't really push back against ever-increasing European rate moves as well. But this week she has done, and she's basically explicitly said— she's warned, I should say, the Governing Council, it would harm the economy's rebound from the pandemic if they were to rush to tighten monetary policy.

Well, I can tell you one thing for sure, that that sentence you've just said, the ECB rushing to tighten policy, that's a complete oxymoron. The ECB will never, never rush to tighten policy. And I just find— do you think the ECB will ever raise interest rates ever again? It's a more interesting topic for debate. Do you think they will ever raise interest rates? Ever?

Yeah. OK. Yeah, they will.

If they can't raise rates this year, which at the moment that's basically what the communication is, they're not raising rates, maybe at the end of the year, right? We're kind of pricing maybe December. If they can't— We're in one of the most alarming inflation spikes that we've seen for 40 years. And if still financial economic conditions can't lead to some inflation in that continent, if it can't happen now, it's never going to happen.

And on that note— Let's end it there. Um, I think that we've, we've got a good amount covered now, uh, in the episode. We'll save some for next week. Um, but look, again, thank you to our partners at Morgan Stanley for, for really getting involved with the Amplify Me mission. And yeah, as Piers said at the beginning, if you've— if you're a student, you're listening, whether you're a college, high school stage, or a post-grad, just, just get involved. Amplifyme.com, check it out. Just book yourself in on the next Finance Accelerator. And yeah, perhaps, you know, you could be the next Serena. So Piers, thank you, and see everyone next week. See ya.