Ep.95: Stocks Fall As Central Banks Stay Hawkish

Okay, hello and welcome to episode 95 of the Market Maker podcast. And it's been a heavy central bank week, really the final big week in the run-up to Christmas and New Year. We had the Fed, the Bank of England, and the ECB all deliver their interest rate announcements, and that's going to be the main theme we're going to talk about. On the back of that, of course, there was also important information in regards to inflation, which is the key metric that these central banks are watching. We had UK and US CPI, so also touch on that. But before we begin, I do have Piers with me back on the show.

Hello!

And we had our Christmas party, the Amplify Christmas party was yesterday, and when we left, um, one location to move to the next. We just so happened to be walking behind a certain individual on a very meaningful day, all things being considered. So, Piers, perhaps you could, um, reveal who this individual was.

Yeah, it's quite, um, it's kind of a function of our sort of, I guess, job career that we kind of got a little bit sort of, um, well, we got quite excited, didn't we? We're like, well, basically it's a celeb, like, pretty much a celebrity spot for us, like, right in front of us.

You were excited, I was scared, because you normally badmouth this guy on this podcast. I was a little bit nervous because he's actually quite a bit bigger than I thought.

He's quite stocky, isn't he?

He's quite stocky, and he's He's tall and stocky, which is a deadly combo.

Yeah, but yeah, no, it was, it was none other than, um, Andrew Bailey, Bank of England Governor, just fresh out of the Bank of England where he had just spent the afternoon, um, well, I guess spent the morning and then midday, um, decided to hike interest rates. So yeah, and there he was just trotting on down the, the road with his bag, I guess, just heading— I don't know, I reckon he was just heading to London Bridge.

Well, yeah, I've had a quick look. He— I assume he was actually. I've not managed to pin down his exact location, but apparently he lives in South London. Okay, so given the fact that I also had a look, because we said at the time, like, surely he lives nearby because he is, you know, banking half a mil salary as the BoE governor. Yeah, so his salary is actually half a mil, but he gets an extra $75K top-up for his pension as well every year on the back of that. Um, so he's probably— I reckon he's probably a Dulwich Village kind of guy if he's heading south of the river.

Yeah, but I, but I was a bit— well, I was a bit disappointed. I mean, obviously I was quite, quite excited when we were just literally walking right behind him, but then I don't know, Jerome, he's not going to be just hitting the street as a normal commuter, is he? Jerome Powell, he'll be limo, won't he? Limo taxi service, luxury taxi service, I reckon. You won't find him walking to the tube.

Yeah, and there was something a little bit, a little bit sinister about his demeanor as he was walking in a very like odd kind of slightly looming, dooming kind of way.

Yeah, it's trudging along. Yeah, it's a man who's like entrenched. Yeah, in a, in a, in a view and a purpose.

Yeah, because everyone around him— because bearing in mind this is a city, the city on a Thursday night, peak Christmas season, um, so he's probably quite scared for his safety, I would have thought, when he's walking through.

I'm just— yeah, I'm just surprised he was just kind of one of the people.

Yeah. Yeah. All right, well, you know, Andrew, if you're listening, good to see you yesterday.

Friend of the pod.

Well, look, let's, um, on that, let's kick off with the decision that he presided over, which was the Bank of England. They did hike interest rates by 0.5%, which is very much as expected. It takes interest rates in the UK now to their highest in 14 years at 3.5%. The vote count was a three-way split. There was a little bit of speculation circulating earlier in the week about a potential four-way, of which, if that were to occur, would have been the first time since '97 or something like that. Um, I guess there might be a question you might be thinking, which is, what is a three-way? Let me just clarify exactly what a three-way is. We're talking about monetary policy here.

Ah, okay, right.

Yeah, still with me. Um, so what this is, is there's 9 monetary policy committee members, and a 3-way split basically is a division of how they voted. The majority hiked, or wanted to hike, 50 basis points, which is what materialized. 2 wanted no change, while 1 wanted to go 3/4 of 1% rather than 0.5%. So you can see there the kind of absolute opposites of opinion. Going from let's just leave rates, we've hiked, I think this was the 9th consecutive meeting, we've done 9, 9 of these now, let's stop. And I'm sure we're going to talk about that because I know you've kind of fell in that camp. Or there's someone else going, look, let's just hike another 0.75%. So just before I hand it over to your thoughts, so Tenreiro and Dingra, they backed leaving rates unchanged. Their reasons were— they cited a weak economy, signs that the existing rate rises were already starting to affect the jobs market, and the full effect of those 9 is still to come through, right? And obviously this week, which we can also look at, UK CPI fell. So your thoughts on the actual—

well, it's not— it wasn't a surprise, so, you know, another hike, but albeit a smaller one at 0.5%, was what markets were expecting. So that's what happened. But yeah, I'm definitely still in the camp where I think it's an error. You know, there he was walking along the street last night, and yeah, I just think he's got it wrong. Um, my personal humble opinion, I think that the especially in the UK, more so than the Fed in the US, and more so probably than the ECB in Europe as well. But I think because the UK economy and the economic outlook for the UK is worse than it is for the other regions, then I think there's even more reason to put the brakes on now. Interest rates going up, it does take time to kind of follow through and have the impact out on the actual you know, out on the street, as it were, in terms of having an impact on borrowing costs and so on. And so all of these hikes they've been pumping through, you could argue that actually none of them yet have really had a full-on proper impact. It takes like 6 to 9 months of a kind of lag from the interest rate to change, and for then that to have be fully felt in the underlying economy. Okay, 6 to 9 months. So here we are, And we're heading into 2023 and look, we're going to have a big recession and they're hiking too much now. And I think this will come through to be very apparent next year. And look, they're going to have to cut again. But I think any hike from here is a mistake. So I think yesterday was a mistake. But look, what do I know? I mean, what Bailey said was a further full forceful monetary policy response. Was required. And, you know, who knows, maybe more to come. So yeah, I don't know, I just, I just feel like they've overdone it now.

And have we, have we seen peak inflation already? Because inflation was at 11.1%, the reading we had this week. It dropped to 10.7%, which was actually low expectations. Yeah, the inflation declined largely due to a cost of petrol and used cars, along with tobacco, clothing, computer games, and hotel stays, for all the reasons. But still impacting the cost of living crisis was that food prices are still going up. Yeah, they've risen by around just shy of 17% in the last 12 months.

Yeah. Oh yeah, I mean, so 10.7%, right, that was the headline inflation reading year on year for November. So slightly less than October's high of 11.1%, but still that 10.7% reading is still the second highest reading in this entire episode. Right. So it's still very elevated, obviously above 10%. It's just kind of crazy insane. But just look at core inflation. It's not going up. I mean, look, don't get me wrong, it's not really yet showing signs going down either. But, um, if you look at the core inflation chart, it's very— it's much flatter. Um, and actually we had a reading for November at 6.3%. Now the April inflation reading was 6.2%. So really had like 8 months where it's kind of been flat. It's been oscillating up and down a bit, but basically flat for 8 months. So it's not like inflation's going up. And look, I guess you could say, well, it's not coming back down yet, so we need to carry on hiking rates because obviously these rate hikes aren't doing the job. But that's the error, that's failing to realize that there's a lag between rates going up and it having the actual impact.

So yeah, another supporting factor perhaps for, for you and Silvana and Swati the two ladies who voted for, for holding, because I know you're a trio, is that UK retail sales came out this morning and it unexpectedly fell in November, came in at month-to-month -0.4%. The consensus estimate was for +0.3%. And the reason why I think this is supportive of what you're saying is because consumer spending, as you said many times over many episodes, accounts for about two-thirds of national output. Is key for growth. Now, the decline last month was driven by online sales, with Black Friday on November 25th helping less, right, prior years. Sales of auto fuel, secondhand goods at auction houses, computer goods were also the other key things for the decline. One thing though, so despite being partly offset by higher sales of food and drink clothing, household goods, shoppers generally attracted to some of the early and it's going to be long department store kind of discounting to counteract the kind of economic situation. One of the things is, is that we've had horrible weather here in the UK and train strikes.

Yeah.

Now actually then, if things are already bad and Black Friday has underperformed.

Yeah.

Doesn't matter if you've got discounts in terms of footfall, you can't actually get out there. And one of the things here is the hospitality businesses, because I mean, I've seen lots of shots and things like that, seen a bit. I mean, last night, I mean, peak Christmas season, it wasn't that busy. No, it wasn't, to be honest.

It wasn't. Yeah, I agree. Like, yeah, we went to that bar after obviously bumping into Andy, good old Andrew Bailey. We went into that bar and yeah, it was— it wasn't rammed. I mean, it was quite busy, but it wasn't rammed. But in previous years, you wouldn't be able to get in, like, full stop. It would be a queue, right? So yeah, but look at retail sales. If you want to look at a— if you want to look at a chart that tells you that quite starkly and quite dramatically tells you how bad the UK situation is. Then look at a retail sales year-on-year chart, and it has been heavily negative every month since April. And I mean heavily, averaging about -6% down year-on-year every month since April. And that's going to continue. And, you know, this this inflation thing, it's hurting, obviously. And we're about to tip into a pretty decent-sized recession. Now, there is one— there's one thing, and actually, maybe actually I'll bring it up when we talk about the Fed because it's perhaps a more insightful— it's the labor market. There's just one little thing in this whole equation that's still being quite stubborn, and it's the kind of— Powell has kind of hung his hat on it as the reason to stay hawkish.

I'll talk about that when we Well, look, let's go. I mean, look, the limo's arrived. Jay Powell's just rocked up. So the Fed, they obviously hiked rates themselves by their own 0.5%. But one of the key comments was from the Fed Chair Jerome Powell that we still have some ways to go. This referencing, and this will come back to and link to the ECB of what Lagarde said as well, which is very similar. But along with the increase came an indication that officials expect to keep rates higher through next year, with no reductions until 2024. The terminal rate— so to simplify that, they're just talking about where rates are going to peak in the cycle. So the point of which where officials expect to end rate hikes was put at 5.1% according to the dot plot, which is the expectations of these, these policy officials. Um, quite hawkish comments then. But they did come in the context of headline year-over-year reading inflation in the US earlier in the week. This was the day before the Fed announcement came in at 7.1%. It was below expectations of 7.3%, actually marked the smallest 12-month increase since the period ending December of 2021. Uh, the core reading was also 0.1 below expectations, came in Well, it came in below expectations, 6%, so 5.9%. In fact, shelter costs, which are the biggest service component, so they make up about a third of the overall CPI index, increased by 0.6% last month. Now that's up 0.6%, but actually that's the smallest advance in 4 months as hotel rates declined. So Yeah, did you think, did you think it was quite hawkish what Powell was saying?

Yeah, I think it was more hawkish than expected. Um, you know, we had— so this, if you want to take the full week, on Tuesday we had the inflation data. Yeah, right. And that was kind of positive, right, in that it was— it dropped, as you're saying, further than expected. So you had a bit of a— well, markets were really interesting because markets kind of rallied pretty hard Uh, like stock markets rallied pretty hard off the back of that, but then it did— they— it didn't last. It was quite a sharp rally, and then by the close it had all come back off, and we kind of closed around about quite flat. So markets had to go at that move saying, look, inflation's dropping faster than we thought, therefore the Fed are going to the top— the peak of the Fed's hiking cycle will be lower. You know, we will maybe start to see even rate cuts second half of next year. This is what's been fueling that market rally over the last few weeks, right? The idea that inflation is going to drop faster than the Fed have been thinking, that therefore they'll stop hiking rates sooner, that peak will be lower, and we'll have a recession, and they'll start cutting rates second half next year. That, that was kind of the idea, right? So stocks on the up, but the rally didn't last, which was quite telling. Then you move on to the following day where it's the Fed. And yeah, I think he was more hawkish than expected. Like, one thing he said was it will take substantially more evidence to give confidence that inflation is on a sustained downward path. So he still needs substantially more evidence. Now, I don't know why. I mean, the headline inflation number— well, hang on, here we go. 1, 2, 3, 4. It's been going down 5 months in a row with actually the, the drop in November being the largest one. So it's actually been going down for 5 months and the downward trajectory is just accelerated. That's on the headline reading. Look at the core and fine, it's a bit different, but you still had now 2 down months in a row, um, the move lower being much larger than expected. Sure. I think when you look at the core chart, the core inflation print for November was 6%. I think you need something below 5.9, which was the two readings we had in the summer. So June, July, we had 5.9s. So I think you kind of need something below 5.9 to go, right, actually, if you really wanted definite evidence. So maybe Powell's waiting for that core inflation chart to go below 5.9%. So maybe that's his idea. So he— but because it hasn't, um, you know, he's remained kind of hawkish. And I guess the dot plot was that interesting kind of— that was the hawkish element, right? Because that's where the Fed members, um, predict and tell us what their view is on where interest rates are going to be in the future. So if you take the end of 2023 dot, then it moved up, right? And it's gone up to 5.1%. So remember that the current interest rate is now 4.5%, right? So they're saying 5.1. So that means, number one, they're not at the top of the hiking cycle. There are more hikes to come. That's number one. They're also saying, number two, there— and this is the important bit— there aren't going to be any cuts. At all in 2023. No cuts at all. Remember, markets have been rallying a bit in the last few weeks because they're starting to think that cuts will be second half of the year. No cuts at all. And that— and to give you an idea how quickly it's changed, so the number of Fed members who think interest rates will be 5.1% or higher at the end of next year is 17 out of the 19 members, right? 17 of the 19 think it will be 5.1% or more. If you go to the September meeting, none of them thought rates would be above 5%, not one. So in the last 3 months, 17 of the 19 have revised up their kind of prediction as to where rates will peak, and they're telling us there'll be no cuts next year. Now, that's what the Fed are saying.

So what's so compelling to have such a majority of them holding that view then?

Well, so Powell's angle on inflation, whilst when you look at all the headlines and the charts, fine, they're coming down, his one big concern is about the labor market. And what we have is a gap, uh, I think it's like a 3.5 million job gap, right? So in terms of number of jobs available and number of workers, there's a 3.5 million gap. So that means that the labor market conditions are still really tight. And the Fed, all the different federal districts— because we talk about the Federal Reserve, but there are, I think, what are there, 12 federal districts. So the US, the whole of the US is broken up into 12 areas, and each area has a Federal District Bank, and they do analysis on their own area, right? Economic analysis. And this is released monthly, and it's called, it's called the Beige Book, uh, because it's literally a book. Well, I guess it used to be a report that would be given to the Fed in a beige binder, but it's like an economic review of each region. Now, what that region was, uh, the Beige Book was talking about was how companies— so going into a recession companies will normally lay people off, cut costs, and obviously that just spirals the recession because people are losing their jobs, they don't have income anymore, therefore they can't consume, so consumption drops, and this kind of— it's that, like, like that vicious cycle. What we're seeing here is a bit weird for now. Whilst we are getting job cuts, and we've been talking about this in the tech sector, if you look a bit more broadly companies are hesitant to lay people off because they found it a real nightmare to hire. You just can't hire at the moment because of that gap. There's 3.5 million people gap, right? So they're like, oh God, if I do lay people off, I'm going to want to rehire when we're kind of the other side of the recession. But rehiring has been so difficult. Maybe I should hang on to these staff. Even though it's going to be more negative for our bottom line as a company, maybe we should just try and hang on to them so we don't have that rehiring nightmare on the other side. So that means that the Fed believe, because of that tightness in the labor market, they feel that wages are going to stay high. They feel there won't be that demand destruction that you might normally expect in a recession when people get laid off, and therefore they're worried that that will continue to sustain this high inflation. That's their thing. So, and look, I guess they have a point. And so I guess the Fed want— need to keep rates higher for longer to create more pain so that companies do lay them off because they have to, they literally can't afford them. And then fine, you get the demand destruction and fine, inflation comes down.

No pain, no gain.

Yeah. So But the markets, right, that's what the Fed are saying, and that's one thing. Markets aren't so sure. They're not quite sure whether to believe them. Uh, and I think you've kind of seen that this week, although I'd say because markets kind of rallied Tuesday afternoon off the inflation data, then dropped back off and closed pretty much flat, um, off the Fed, uh, meeting itself. Uh, which was Wednesday night, of course, um, we, we got some downside. Uh, no, hang on, sorry, it was quite choppy. And yeah, all right, markets finished slightly lower, right, but not much. And actually pretty much where we were pre-inflation data on Tuesday. So markets were about flat going through the inflation data and the Fed. It's not until Thursday you started seeing things come off. And actually Thursday was a really big down day. Um, So I think maybe the markets are just slowly digesting that Fed news a bit more and actually taking it a bit more on board. Because pre-this week, markets have not been agreeing with the Fed. They don't believe the Fed. Markets have been going, Fed, you're wrong. Inflation is going to come down faster than you think. You're not going to get rates above 5%. You're going to, you're going to cave and start cutting second half of next year. That's what markets have been thinking. So I think, I think there's just a bit more doubt in amongst markets now, and maybe they think, you know, God, maybe the Fed have got a point. And that's why you saw the downside yesterday.

And a bit of the— or exacerbating the weight that's come in to the back end of this week, um, essentially across all global indices, is we had the ECB Yeah, and the ECB hiked, uh, the similar recurring theme of 50. But Lagarde, the president of the ECB, said anybody who thinks that this is a pivot for the ECB is wrong. Yeah, we should expect rates, interest rates, at 50 basis point pace for a period of time. Yeah, and European stocks fell about 3% yesterday. As the lowest level in a month, nearly the most in, in 2, 2 months actually.

Um, yeah, I think of the 3— so we've had the 3 banks, right? The Fed went first, Bank of England, then the ECB. Of the 3, the ECB have been more hawkish with their— they all did the same thing, they hiked rates by 50 basis points, but the ECB were more hawkish, um, more ground to cover. We have longer to go. The ECB is not pivoting. Yeah, probably further 50 basis point hikes for a period of time. Do understand that the ECB are behind the other two in their hiking cycle. Right. And they always are. I mean, it's classic ECB to be just late to the party. Um, you know, so they're interested— they didn't start hiking rates until June, right? The Bank of England started in December, the Fed started in March, so they used to be started in June, so they're behind. Um, and their interest rates are at 2.5%. Um, so, you know, the Fed's interest rates at 4.5% and the Bank of England's at 3.5%, so they're behind. So from that argument, well, they should be hiking for longer than the other two because they started later. Um, but yeah, I think Lagarde's comments really tipped the balance this week. That's why you got the big sell-off yesterday in global markets. I mean, Europe sold off more than the others. I mean, Europe— Euro Stoxx 600 had their worst down day since May, um, because it was notably hawkish from her. And, you know, global markets all came up as a result. So, um, yeah.

So the other, the other factor here as well, probably compounded that, was that complementing the rate push, officials outlined plans for quantitative tightening, right? Offload— that's basically offloading government debt that they had purchased as a stimulus in the past through, through COVID. The plan envisages partially halting reinvestments of maturing bonds under their APP, the asset purchase program, from March. So end of Q1, volumes are going to average €15 billion a month in the second quarter, with the pace beyond that still yet to be determined. So they're just plowing ahead come what may.

Yeah. And again, they're last to do it. You know, the Fed have been reducing the balance sheet, the Bank of England have as well. All right, there was the, you know, Liz Truss saga that kind of just got in the way and had a little—

yeah, we don't talk about that.

Oh yeah, okay. So, um, so yeah, I mean, they're always late. The problem with the ECB is by the time they really get their act together, I'm like, let's go, let's go, let's start tightening, then it was too late because the recession started. So Um, yeah, so certainly the, the hawkishness of the ECB was— they were the most hawkish of the three. That's why you got the sell-off on Thursday. So I think, look, the big question now is, well, we've got a couple of weeks till year-end, and what happens, you know, with markets? Because we were rallying, it was looking Pretty nice. We were, we were talking about the Santa rally and, you know, the scope for a push into year-end. And it's all of a sudden this week, it's suddenly just gone a bit flat. And is that rally into year-end actually, actually going to happen? And in fact, the S&P right now on the futures, we're trading the lowest we've traded for a month. We're down to lows we haven't seen since the start of November. Now, um, that upward cycle that we've had from mid-October where for now it looks like it peaked end of November, just around 4,100 on the S&P. So that 6-week rally, when you're looking more on the longer-term chart, where that 6-week rally has peaked, it's pretty much right on the downward trend line for the last 12 months. So technically, the index has turned at the trend line and has now been going down for a couple of— well, for, for, well, this week, and then set the lowest levels we've seen for like 4 or 5 weeks, right? So technically it all looks quite neat and tidy. The downtrend's still in play, and maybe we go lower. I mean, thinking about, um, valuations— well, yeah, valuations have obviously come down because the market sold off all year, right? Thinking about S&P PE ratios, I mean, at the peak it got a bit crazy in 2021 where the average was up around 25, 26 times P/E ratio, which is crazy, crazy high, right? We've come off, we're about 17 now. So the S&P is trading at 17 times P/E. Now that in itself is about mid-level, it's about average, uh, meaning Stock prices are not pricing in a recession right now. They are not pricing in a recession. If they were, we'd need P/E ratios to be going down towards 10, right? 10, 12 area. So you might say from a— if you think there's going to be a recession, stocks do need to go lower to price that in. But maybe you don't. I mean, yeah. I was quite confident we'd get a rally into year-end. I thought maybe get to 4,200 in the S&P. Now I think that's definitely less confident about that.

Um, but do, do we go to 3,600?

I, I don't know. I don't think so. Personally, I don't think so. I think, I think we will slide sideways into year-end. That 6-week rally is kind of done. But I don't expect a big sell-off unless stuff happens. And material— like, you know, you like looking at the headlines today, like in the FT, obviously we've got— looks like COVID cases in Beijing, um, are on the up. So whether, whether that comes in and plays a role— I saw Russia are selling oil to India at, you know, the European price cap. Or I should say the West-sanctioned price cap. So looks like Putin's caved and is going, oh God, all right, fine. I have to use these ships that are only going to get insured by the European insurers. I can only use them if I'm selling oil below the cap of $60. And it looks like that's happening. So you could say that's a good thing from an inflationary point of view. It's a good thing from an oil supply risk point of view. So that's a positive, but that, maybe that reverses again, I don't know. So yeah, I don't think there's, we kind of, we've had the last major kind of macro stuff now. This week was, this was the big week of the, you know, the last big remaining week of the year with the CPI prints and the central banks all coming. And the net sort of conclusion is, Inflation was looking good, it's dropped more than we thought, but the central banks have stayed more hawkish than we were expecting. So net-net, it's kind of, uh, that's annoying, and markets might just flatten off into the end of the year.

Cool. All right, well, on that conclusion, uh, this will be the last episode until we're back in the new year. I think it will be probably the 6th, I think, by the time we get around to the the welcome back to 2023.

What episode are we on here?

We're on 95.

95?

Yeah.

Okay, so we need— so we're going to drop some plans for the big 100. Well, we need to start, yeah, formulating about this.

Yeah, well, look, there's going to be not just the 100, lots more to come from Amplify. We've been having lots of strategy meetings Anthony Cheung: the team and I over the last couple of days about lots of exciting new simulations that we're going to be coming to market with. So for sure, stay tuned. If you're not subscribed to the channel, please do hit the notification bell as well, and you'll get an alert as soon as the new episode comes out in the new year. Stay safe, stay warm, enjoy your Christmas, have a great new year. Piers, thank you for, um, the last 12 months joining me on here.

Yeah, well, Happy New Year, Merry Christmas, and yeah, have a, have a great break.

All right, take care everyone.

See you guys. Bye.