Ep.70: Is Fed's largest rate hike since 1994 a mistake?

Okay, hello everyone and welcome. This is episode 70 of the Market Maker Podcast. This is Piers Curran. Today we're changing it up, the lineup. I'm, I'm actually joined by my co-founder Will DeLucy, um, because Anthony Cheung— breaking news— Anthony Cheung has just had his second baby, uh, or his wife has. Basmah. So, um Yeah, I think he's got a decent excuse, uh, for not being on the pod, uh, this week. But I just want to say, Anthony will be listening, so I just want to say massive congratulations to Anthony and Basma and his family. So huge, fantastic news. Um, but yes, it does mean you're not going to get your weekly dose of Anthony Cheung, I'm afraid. But, uh, we do have Will DeLucy stepping into the fray, so I'll come on to you in a sec, Will, because as As normal, there is a running theme, and it's happened again. When Anthony Cheung goes away, the whole world collapses. And yet again, so let me roll off some stats for you. In the week that Anthony Cheung decided to step off the desk, there's definitely— it's definitely connected, this. So what's happened? Well, Obviously, the big news is the Fed. They hiked rates by the largest amount in a single meeting since 1994 by raising interest rates by 0.75%, or otherwise known as 75 basis points. Outside of that, and we're obviously going to drill down into that in a lot of detail, other stuff doesn't even make the top of the list. The ECB convened an emergency meeting on Wednesday. That was just 6 days after their interest rate setting meeting that was scheduled last week kind of almost unprecedented this. So we'll talk about why. I'll briefly cover why and what they've decided. And it definitely kind of harks back to the dark days of the eurozone debt crisis that, Will, you'll remember very well. But in terms of market moves this week, well, the S&P has continued to fall through the floor and as I speak is down around the 3,700 area. That means it's now officially in bear market territory. It's down 23% now from the November high. The NASDAQ is now down 32% from the November high. Um, the dollar has been punching its way higher all week, uh, now back to, uh, versus the euro, back down testing the 1.04 handle. This is the low of the year. Um, against the pound, it has made new lows for the year. And trading down around the 121 handle at the moment. And that's an 18-month low. And you know what? We're not far off levels now, back to levels we saw in the aftermath of the Brexit vote down back in 2016. And then perhaps the biggest moves from a sort of percentage point of view this week is in the crypto space. Bitcoin down, well, roughly about 33% just this week. Uh, that puts it down 50% on the year and 70% down from the November highs. And of course, other crypto coins, just, yeah, huge downside pressure this week. Uh, the crypto miners, uh, have been kind of wearing a lot of pain. So we'll kind of delve into all of this in the pod. But look, let's start with the Fed and, well, just get your initial take. Well, they obviously hiked rates by 0.75%. And maybe if I just give the stats, and then I'll be keen to get your thoughts on, you know, if you think they've made the right call here, and then we can discuss in detail how markets responded. But just here are the kind of the stats. They raised rates by 0.75%. You'll remember that just sort of last week we were pretty much 100% pricing in just a 0.5% hike, but they've hiked by 0.75% because of the much higher than expected inflation print that we had on Friday. So this takes the Fed funds rate now up to a range of 1.5% to 1.75%. The Fed operate a bit differently to most central banks in that they don't have a single interest rate, they have a range which is 0.25% wide. This, as I said, was the biggest single hike since 1994. They also, they said in their statement, they anticipate that ongoing increases in the target range will be appropriate. At the meeting yesterday, there was only one dissenter from the FOMC committee, and that was Esther George. And George actually preferred just the 0.5% hike. Not surprising, George is the uber-dove on that committee. But otherwise, every other person on the committee stepped up to that 0.75% range. Powell added because there was a press conference afterwards, of course, and he added that an increase of either 0.5 or 0.75 percentage points would likely— was likely at the central bank's next meeting, which will come at the end of July, although he did say he did not expect adjustments of that magnitude to become common. So What do you reckon of all of that lot? And try and explain that to me.

The last thing that you said there is he does not expect rate rises of that magnitude to become common. That comment came about, well, within about a 10-minute window of the other comment that they anticipate ongoing interest rate increases will be appropriate, which the market took as 0.75 to come. So let's perfect central bank fodder. For people out there who might be new to watching central bank conferences, sometimes it's almost as if their task is to equally weigh their statements and sentiments so as to avoid really creating too much volatility. So hence why you had the S&P actually first lower, then higher, then lower, then higher again. And then actually this morning, I think everyone's been able to reflect on this and say, well, okay, they're saying that no bumper or, you know, it's not going to be, um, jumbo rate rises will not be common. But I don't know. I mean, for sure, by opening up the casket to 0.75, um, they can do 0.75 again and again. And I think, um, the best thing I saw in the FT was, was the change in the interest rate expectations going forward. The Fed Actually, it just to me shows how wrong they were even going back to December, still holding on to that transitory. It's not me, it's you. Transitory will come down. I mean, I think they've been sorely wrong-footed. And in order to maintain credibility, the Fed have to be more aggressive now. They have to continue. And I think the next rate hike this isn't the last 0.75 that you've seen with the CPI at 8.6%. And the thing about inflation is, remember, inflation is just a belief, right? It's do people believe that prices are going higher? And yes, you've got the food and the energy driving it. But if you start to now see this come through in a wage-price spiral, then it can really create some pain. So More to come. I think now they're probably doing the right thing. I think if they were dovish in this statement, I think they would have some real problems this summer.

Yeah.

So they needed to show a bit of strength. And look, it's happening what we pretty much have been flagging for a while. These equity prices couldn't have withstood this. I think the tough thing for an investor though, Piers, maybe you can ask this, is where do you put your money now? Because it's not in bonds, it's not in equities, it's not in crypto. Good luck with that one.

Yeah.

Where are you invested and why?

Well, that's the, the, the biggest question of them all, isn't it? Um, it's very, very, very difficult. I mean, pretty much the only thing that's gone up is the dollar, um, and it has gone up By a lot. I was reeling off the euro-dollar and the dollar against the sterling. Against the yen, by the way, the dollar-yen's testing the 2002 high. So it's literally the highest it's been for 20 years. And that's a perfect sort of, I guess, case study for that, the biggest force on exchange rates, which is interest rate differentials or monetary policy differential. And obviously the Fed now uber-hawkish and the Japanese still kind of definitely lagging. But before I answer—

okay, go on, sorry.

But before I ask the question, yeah, where, where to invest your money, um, I'm gonna— what, can I add some numbers? Because you made a really important point, um, and that was about interest rate, um, expectations going forwards and how the Federal Reserve communicate to us how, you know, where they expect their own interest rate levels to be in the future, and they use what they call their dot plot matrix. And so for those of you not quite familiar with that, I'll try and simplify it. Basically, each quarter, each member of the Federal Reserve Committee plot a dot on a chart, and their dot is to represent where they, as an individual on that committee, where they expect interest rates to be at the end of 2022 where they expect rates to be at the end of '23, where at the end of '24, and then something called where do you think rates will be in the longer run? Okay, which is where you think, you know, where's the top of this cycle and where will that kind of natural kind of rate level settle down to? And you said quite rightly, and there's a great graphic in the FT today, I will— if you get anyone who's got a subscription to the FT, it's the first article on the homepage. Just go to that, it's about the 0.75 rate hike, scroll about halfway down, and they've got a great graphic which shows you how the Fed's own sort of forecasts have changed in the last sort of 12 months. And as you said, it's so— it's the, it's the biggest hawkish pivot I've ever seen. And so to put some numbers on it, uh, so if you go back to the September meeting September 2021, so 9 months ago, the Fed themselves were forecasting that interest rates at the end of 2022 would be zero.

Wow.

No change. By December of 2021, they updated it. Of course, during that quarter 4 of last year, that inflation thing, it changed from being, nah, don't worry, guys, this inflation uptick is transitory, it's temporary, it's going to go back down, don't worry about it. And it moved from that stance to the end of the year to, oh, ah, hang on a minute, uh, it's not kind of going down like we expected, maybe it's not transitory. And so they started to say, look, we're going to probably have to start hiking. So in December, their forecast for the end of 2022 was rates to be 0.75%. Okay, then you go to March, right? So March 2022, now the meeting in March, they updated their dot plot again. And now of course inflation is really taking hold, and they upgraded and they said, right, by the end of 2022 we expect interest rates to be at 1.75%. That's what they said in March. They've just hit 1.75%. So in the meeting yesterday, the dot plot They've now taken their rate expectations for year-end up to 3.25%. So just if I summarize, in 9 months, they've gone from an expectation that rates will be zero at the end of this year to now 3.25%. Wow. Now that right there, that perfectly explains what I mean when I say that's the most aggressive hawkish pivot I've ever seen and definitely explains all that's happening in markets.

To me, it's just a huge admission that they were wrong. I think they need to be held onto account here. The Fed chart I know that you're talking about in the FT, I really like because it moves. But actually, I'd like to see a chart over time once all of this is over, is what the Fed told us would happen and what actually happened, and hold them to account. Because it really is like— I mean, you know as well, running a business, we make forecasts. And we're held to account on those forecasts. What the Fed are doing is changing that forecast. Oh, no, hang on a minute. I need to change that forecast again. And they should be held to account for that. So I do think the— obviously, I mean, that goes all the way back to 2020, $20 trillion plus being created, both monetary policy and fiscal policy in a response to COVID. More liquidity upon more liquidity. And then the Russian crisis making a perfect storm with the scenario. But you can't create a tidal wave of money and not have to deal with the outcome at some point. But it went on for longer than we thought, right? Because I mean, you and me, we were trading back in 2010, 2011. Do you remember when gold went to $2,100 in 2011? Because As a result of Quantitative One and Two, everyone was saying, oh, this could create some price pressures actually. And it didn't materialize for another 11 years.

Right.

This is the challenge with markets. Behavior shifts so fast. And if the market— the amount of liquidity in financial markets and the central bank experiment, we've been talking about it for years. But it hasn't been a problem because no one's looked at it as a problem. And this is what I find so interesting about the behavior of markets in history, not just now. Everything's fine until it's not, and then behavior changes almost like a jack edge. And that's what's happening now. And this is why I think the Fed do have a challenge, because inflation is now in the system. It's in everybody's beliefs. And That will be the trend. You haven't answered the what to invest in yet. And I understand that you were very political of you. But let's go back to that. So what do you invest in now?

Well, before I answer that, I'm just— basically, so to answer that, You got to now think, right, well, what's coming next? Right. So what is the outlook? And I was just trying to figure this out, right? Because if they now tell us by the end of this year, rates will be at 3.25%. I was just trying to figure out what does that mean? Because there's 4 meetings left this year. Okay. 27th of July, 21st of September, 2nd of November, 14th of December. So there's only 4 meetings left. Okay. We've got rates at between 1.5% and 1.75% now. Let's say they do another 0.75% in July, which all the big banks have now got kind of locked in. That's Goldman's forecasts, and Powell pretty much said that's going to happen, right? So assume that happens. Okay. That would take rates up to 2.25%. Okay. That means they got another 1% to do over the final 3 meetings, September, November, to December. And it might be that it's 0.5 September, 0.5 November, and then leave it at that, or maybe 0.25 in November, 0.25 in December. So I do personally think that we are right at the— this meeting yesterday and the one in July will be the kind of peak hawkishness, if you like. Right? And then, well, the Fed hope that's the case. Obviously, we need to see that then feed through on the inflation side and enable the Fed to just take their foot off the gas a little bit. But as you quite rightly say, the Fed got it big time wrong last year. And who's to say they're not big time wrong now, just in the opposite direction? They underestimated inflation in 2021. Are they just overestimating it now? I mean, I know the CPI print wouldn't suggest they're overestimating it, but where do I think markets go from here? I think there is still more downside between now and the next meeting. And I can't describe how important the next inflation data is out of the US, and that'll be mid-July, and we'll get the inflation print for the month of June. And that I mean, it's big anyway, but that now becomes the next big line in the sand. And you're going to have to wait for it before making any big calls on what markets do next. You're going to have to sit on your hands and wait. I mean, you need that data, I think, before you can start to really look forwards with confidence with a strategy.

I think that's why there's so much uncertainty in the markets. And if you look at how the equities moved, Um, I was actually speaking to, um, really interesting hedge fund yesterday. So we've had a number of candidates— well, obviously we help students all over the world secure roles— and there's a hedge fund called Quadrature, which is really a technology-led automated trading firm. They're in Leadenhall Building in London. It's the most amazing offices I have ever seen. Super, super cool hedge fund. They've got a ski chalet They've got games rooms, they've got, I mean, whatever you want in the top floors of the newest building in London. Phenomenal. But I was there because someone that did our training program 10 years ago, Yusuf Ali, is now the head of equity analysts and really running the execution desk there. So interesting to see how well he's done. And he was saying, look, We're at a time now as a hedge fund, and they're doing really well in this environment, but they're saying they're going back 60 to 100 years to look at data and correlation to try and find historical patterns where you've had rapidly growing inflation, hawkish central bank, but after a period of a supply and demand shock. So interestingly enough, you're saying, well, actually, if you look at 1945 to 1950 after the Second World War. And I saw the FT was talking about this, and he goes, in some ways that was quite similar because you've had reduced demand over a long period and then suddenly the floodgates open. Um, but in that response to that inflationary pressure, actually the central bank was able to manage the situation quite well. So slowly move interest rates higher, and it was all relatively orderly. Whereas obviously in the '70s, the opposite was true. But what wasn't the case in the '40s, the big difference he was saying is we are entering this environment now with phenomenally high asset prices. Obviously in 1945, we've just had two world wars and it was very different. Whereas we've just had here 12 years of relentless asset price appreciation. We had negative interest rates for the first time. You had the European Central Bank not only buying government bonds, buying corporate bonds of random companies everywhere. You had helicopter money where central banks have literally been depositing money in people's accounts and saying, please spend it. Um, so we've never seen anything like it. And he was saying, for their data mining, for their models It's actually really interesting how far back you have to try and go before you've seen an environment like this. And I think that's why there's still going to be a huge amount of uncertainty in the markets. It's from here, Piers, I think it gets really interesting. And those automated trading companies, I mean, they're poised well, but some, some are suffering. Some hedge funds are really suffering trying to predict the global macro impact here. I think one of the reasons why you've almost successfully dodged my question twice now, is it's hard to predict. I mean, the correlation between assets is so strange, so groundbreaking. And I think you could have a global macro view now, but within one week you'd have to change it. Yeah.

Yeah. Peak uncertainty. And I guess my biggest worry, just back to the Fed, are they right? Are they wrong again? I guess What I worry about is the inflation pressures are— well, as far as I can see at the moment, are mostly on the supply side. So it's the Ukraine conflict that's led to commodity pricing spiking. That's supply side. And then obviously supply chain problems with China, zero COVID tolerance and so on. I mean, that's again supply side. So I mean, I know wages are rising, and I guess that's your— you pointed to it— that big worry is that wages rising then lead that what is a supply-side problem to become then a demand-driven problem, and then that's where inflation can take off.

But hasn't the demand-driven problem already happened? Yeah, it's almost like the reverse way around here, which is what's unusual.

So that's what I think though. So, so I guess my point is, if it's a supply side situation, rate hikes aren't going to solve it at all.

No.

So aren't we literally going to have the worst of both worlds here, where inflation is high because of the supply side and the Fed hike aggressively thinking they can somehow have an impact?

Well, I think it's more interesting than that. I think you're saying such a good point here. I think they know, and you've got the Bank of England, what, just a few minutes anyway.

Yeah.

I think they know, as central banks, raising interest rates here won't change supply-side inflation. But you know what? They've got no choice.

They have to.

They have to do it, even though it's probably the wrong thing to do. If they don't do it, they then lose credibility. And if they lose— if This is the big one for me. If faith in central banks dissipates, I mean, forget 2008 or whatever we've seen. I mean, because they are so fundamental now. I mean, it used to be that they just decided on interest rates up or down. But now they are the backstop scaffolding and support of every single asset, job, product out there. I mean, they really are endemic in the system. And, um, yeah, so they have to raise rates. They've got no choice, even though it's probably the wrong thing to do.

So talking about central bank, um, credibility, then let's, let's just move on to the ECB, because quite amazing, I, I think, and it's kind of gone a bit under the radar given how dominant this Fed story is, but the ECB had a meeting last week And that's their scheduled meeting. These banks, they have a meeting every 6 weeks. It's all scheduled in. We know exactly when the dates are for the whole year, and it's all nice and proper. And the ECB met last week, and they went along the hawkish path as well. And they said, look, we're going to start to raise rates next time, i.e., in July, and we're going to look to obviously also wind back our QE program. Right. And so, you know, kind of as expected. But then literally 6 days later, the ECB call an emergency meeting. I'm like, what? It's not like 2011 here. What's going on? And actually, what happened since last meeting was Italian and Spanish bond yields had started to rise because there's a little bit of concern that if the ECB pretty much— well, certainly the very biggest buyer in town of these bonds for, well, ever since, what was it, 2015? I think they rolled out their QE program. For the last 7 years, the ECB has been—

Since Mario Draghi's whatever it takes.

Absolutely. What a ledge. So the ECB is saying, look, we've bought enough, we're going to stop. And of course, obviously what happens? Well, so yields of prices go down and yields go up, right? The biggest buyer in town announces that they're out of here. And the issue is that the Italian and Spanish yields rose to an 8-year high. And briefly, the Italian yield, 10-year yield I'm talking about now, went above 4%. So on Tuesday, it closed at 4.18%.

So we can get a return with some investment somewhere.

Absolutely, finally. But it's dropped back a little bit now to 3.78. But it just kind of flashed on the radar. And the ECB go, "Ooh, all right, we best perhaps try and get in front of this." So they had a meeting. And then the idea was they were going to speed up work on a new policy tool that they're calling the new anti-fragmentation instrument. And basically, I think the plan to start with, they're going to stop buying bonds, but they're going to continue to reinvest any bonds that mature, that money they'll reinvest. And I think what they're going to do is that reinvestment will be geared more towards the more fragile eurozone economies. So basically, they're going to try and prop up the prices of the Italian and the Spanish and the Portuguese debt rather than buying German, for example, just to try and make sure those kind of— and it's Italy, of course, that has huge amounts of debt. And if their yields properly spike like they did in 2011, But they spiked to over 8% in 2011, Mike. But we literally thought the whole Eurozone was going to collapse.

But do you remember back then, and perhaps some of the listeners obviously weren't here back then, but we would always look at the spread between Italian yields and German yields or Spanish yields and German yields. And when that spread would widen, actually concern over the Eurozone would heighten. And then when the spreads narrowed, then actually it would become much more secure for the eurozone. So yeah, following those spreads is crucial. But I think what you've just described from the ECB shows just how difficult the situation all central banks are in now. Because they've spent the last 13 years being the scaffolding of the financial system. What used to happen— do you remember I used to, when teaching about this piece, I sort of imagined someone holding a toddler and then letting go, and then the toddler wobbles and they grab it again, right? That's what central bank— that's just what the ECB have just done. They try to let go and then they quickly grab it. And I think what we're going to have here is another lesson with central banks trying to let go again, trying and then grab. I mean, but the difference now is you've got inflation. Over the last 13 years, they used to be able to do that. I mean, you remember 2011, right? Where Jean-Claude Trichet hiked interest rates twice before before that was reversed immediately and everything reduced again. But they could do that because there was no inflation. The problem now is the central banks are going to try and step away, try and let go. And the US bond market, by the way, is the even bigger bear in the room here with the amount of money that that's not going to be reinvested. And things are going to go wrong, and so they're going to try and step back in. But every time they step back in, inflation continues. Interesting times. We haven't even talked about crypto yet, talking about volatility.

Let's do it.

Um, yeah, so look, back, back to $20,000 for Bitcoin. That's the sort of target everybody was, was looking at. I shared with, I shared with, um, our trainees actually the video that I did with Tim Duggan in December 2020, which was all about Bitcoin approaching $20,000 from the bottom up.

Right. Yeah, yeah.

And how this time it looked like this will continue to stay above $20,000 and we might move higher to $30,000, or I think my biggest prediction was $40,000 to $50,000. And Bitcoin, as you know, went to $70,000. So yeah, I mean, it was a It's been a great time for crypto assets, but again, it's behavioral now. And you need to know that everybody else is now full-on excited about being long these cryptocurrencies. And the atmosphere out there just isn't saying that. The atmosphere out there is how low can this go? And if we do break 10— 20, sorry, then it's 10. Obviously is the next big round number to focus on. And it's strange, as you know, we're developing our own blockchain sim to help people know all about the technology behind it. I think it's so interesting. But I do think the value of a coin, whether it's Dogecoin, Chainlink, or Uniswap, it is quite— I mean, it really is just purely behavioral because Obviously, it's behavioral. So I think it's tough. And I think it's tough for most people now. I was reading in the FT, the average person has now lost much— Bitcoin is below where the average person has bought.

And I'm sure— well, can I ask you? I mean, I'm sure a lot of listeners perhaps will have some kind of Bitcoin or other crypto exposure. What would you do now? I mean, obviously, you can look at the technicals. And you said $20,000 on Bitcoin, such a massive level. It was the 2017— —high, and then—

well, it's held for now, just to be clear. Right.

But what I was going to ask, from a psychology point of view, you know, if you're listening to this and your crypto account's just taken an absolute battering, and maybe it's the first time that you've been in a position where, uh, you know, your trade is losing a lot of money, what would you— what's the best mindset? There's a really good question.

There's a couple of ways to manage this, and I've done this myself with different trades, whether it's in Gold, or when we're trading bonds full-time much more aggressively. You've got to decide now what you're going to do. So hear me out. You've really got to decide now and almost write down and commit to what you're going to do. You can't rely on yourself to do the right thing at the right time because all of the behavioral problems get in there. Oh, is it going down? Is it— oh, maybe not. Maybe next time. My outlook would be like this. Depends if you're a short-term or long-term holder. If you believe in Bitcoin with every nerve and sinew of your body, then just don't look at it again for the next 10 years, close everything down and move on. Because fundamentally, if that's your view, then you shouldn't be looking at the price anyway. But if you don't want to lose money here, then this is what I would suggest. You've got the level at $20,000, okay? And that is a really important level. If we break below that level, and then on, on a proper break, I mean, we go from $20,000, let's say, down to $19,500, and, and we don't immediately reverse it. So, you know, if we stay below $20,000 for a few days, I would suggest you pre-committed to taking your position off. Just take it off. Right, it's below a really significant level, take it off. If it helps, you can just put a stop in. The issue is you'll find it— just be prepared— if you put a stop in, you know what's going to happen. It will go down and hit your stop and then go back up, because that's life. Um, but you need to be okay with that. You need to already know that I'm going to put my stop in. If it goes below 20,000, I'll get out. Sod's law, it'll probably rally back higher, but you have to be okay with that because the risk of it not going back up is too high. Psychologically, you can say to yourself, if we're below $20,000, I'm not interested. Just as simple as that, and get out. Then if in the future we get above $20,000, and then— or not even, we might even go down to $10,000, $5,000, but you don't care because you're not long anymore, right? But then in the future, if you then start to see genuine real demand, we start pushing back above these important levels there's real momentum behind it, you can pre-commit to getting back in. So you can say, right, I'm getting out at $20,000 and I'm going to be watching for a while. And if we go down below $10,000 or $5,000, you can watch. But you can say, okay, now I've— now this— I believe this sell-off has happened. If we break back above one of these key levels with real conviction, then I'll get back in. And that's it. So I think for me, if you're, if you're holding it 20,000 is key. I think you need to look at saying committing to getting out if there's a significant break lower below that key level, but always knowing that, look, in 3 months, in 6 months, I can get back in. And what tends to happen with this type of thing, you know, as soon as you get— got out, you'll be watching it like a hawk. Should I have done it? Should I— have I done the right thing? Have I not? Have I done that? And you'll torture yourself and you'll go through that whole process. So again, I think preparing for that, knowing that's what you'll do, is fine. But because otherwise your only other option is just to continue holding it no matter what.

Well, that's it. Very wise words. Hopefully the listeners will take some of that on board. So let's kind of wrap it there. I will just say, because we're recording this Thursday midday, so the Bank of England have just announced they are raising rates. They've just gone with a 25 basis point, another 25 basis point hike. So that takes UK rates to 1.25%. Um, two members of the MPC, Haskell, Mann, and a guy called Saunders, both opted for a 50 basis point hike, but the other 7 members voted for 25 basis points. So they've gone with the majority. So another hike from the UK there. But look, uh, we will wrap it up. Thanks very much for your very interesting insights, Will. And be safe out there, guys. Markets are definitely super dangerous though. Everything's still on its lows and making new lows. So, um, we'll see how things wind up into the weekend. But, uh, take care out there, guys, and all the best.

Thanks a lot. Bye-bye.