The Trading Floor: The Fed's Bold Strategy

Welcome back to the Trading Floor, and ideal timing, I hope, because two major market events this week. We had the US and the UK central banks with their interest rate decisions. So we're going to look to just unpack some of the major headlines, how the markets reacted, and what might come next. And hopefully this is super useful for whether you're in the application cycle or if you're just trading yourself and you're an investor. Hopefully this short episode will help. To start though, Piers, someone— shout out to Mike Ivy. You might remember Mike from back in the day. He dropped me an email. Haven't heard from Mike a long time. Mike, I know you're an avid listener. Hope you— hope you're well. But he sent me a screenshot of Mr. Piers Curran, a screenshot from a previous episode with a little quote that you made.

Oh no. Oh no.

And it said, quote, the rebound's over, baby. And I think at the time we were something like 5,660, something like that, in the S&P. I think we clocked close to 5,800 yesterday, that being on Thursday. We're recording on Friday. So, you know, you just like to put your feet on the fire just to kick this episode off.

Look you know, sometimes I get it wrong. You know, these things happen. And actually, uh, I think in my defense, possibly, uh, when my, my thesis there where I was saying the rebound's over, baby, um, I think I did kind of set out a set of circumstances. We know what needs to happen if I'm wrong kind of approach. And, and my thesis was based off the Fed not cutting by as much as the market was expecting. Of course, they went big and, you know, they have cut more than I thought. So yeah, uh, I was wrong. My prediction on the Fed was wrong. So it makes sense that my prediction on the market was wrong. And, uh, bang, new all-time highs, baby. Yeah.

So yeah, let's just go over the headlines first then. So the Fed cut its benchmark interest rate by 50 basis points, 0.5%. and they signaled further reductions to follow. It's the first rate cut we've had in 4 years, was a timely reminder that a lot of the press felt like they needed to tell us in regards to since the COVID crisis. So that puts the range now at 4.75% to 5%. Now, one of the major things here, um, that seemed to be one of the major themes that people, the market commentators, were talking about was the preemptive nature of this move.

So, right.

What is it that they're basically saying when they say that word?

They are, well, preemptive. They're basically making a move now, uh, in order to, um, avoid a, you know, negative economic situation in the future. Basically. Um, they, yeah, I mean, look, I'd say, I mean, this is quite a big This is a big moment. Let's just take a step back here. As far as I recall, this is the only, um, interest rate cut of more than 25 basis points that I've ever seen outside of a crisis. So it's the biggest non-crisis rate cut in my whole career, which kind of stems back till the start of the century. Right? Um, so it's a big moment, and look, hats off to Powell, to be honest. Um, you know, I like it. Um, I didn't predict it, and that's because I think the way of things is that the central banks tend to be a little bit more cautious, and they, you know, their whole point was, look, let's not, let's not cut too soon. Yes, inflation is down and approaching our 2% target. It's not there yet. Let's not cut too soon and basically stoke inflation back up. Um, that was kind of the cautious, typical sort of central bank that you would expect. But this is, this is none of that. This is absolutely, we have won the inflation battle. Inflation has been slain. And right, rates are too high. And look, the unemployment rate is ticking up. Slowly, let's go big and make sure that unemployment rate rise doesn't continue at this pace, and let's try and land this without, you know, avoiding a recession is the message. So it was quite interesting to see the kind of market reaction on the day because Powell cut rates— well, they cut rates on Wednesday evening, and, you know, it's really interesting to see the response because actually initially it was kind of, right, markets popped higher, then they kind of sold off, and actually they sold off the entire rally and actually made new lows for the session just before then bouncing into the close. So on, on the Wednesday market session, markets actually closed unchanged, having had a big rally, having had a big sell-off, and then finish in the middle. It was Thursday where then markets said, actually, you know what, this is properly good news for us share prices. And you had a big pump to the upside as the S&P made new all-time highs. Today, Friday, it's kind of flattening off here. Well, we're about 15 minutes from the US Open, but futures are kind of flat to slightly lower. So giving back, we come off the highest point from yesterday, but, you know, consolidating most of that rally. So that seesaw action on Wednesday Because look, there's two ways to take this. It's, um, negatively, and the negative argument is, wow, 50, why have they cut by so much? That's unusual. Is it that they know something we don't? You know, do they fear that this job market is really starting to unwind and actually there's a larger recession risk than we thought? You know, why else would they be you know, so dramatic with the size of their cut. That's the negative spin, right? The positive spin, which is what we've now seen certainly on Thursday, was actually the Fed are right here, um, you know, they're going big because interest rates are really high and inflation is back and it's dropping. So let's forget about inflation. And if you forget about inflation entirely, well, then it's just about the labor market, and the labor market's cooling 'So let's cut to make sure that cooling doesn't, you know, gather momentum when we end up with a recession.' So that's the positive one. It's like the Fed have been bold, they're preempting a recession by going early, and the markets have loved it.

And the other thing, the other element of this was it wasn't just a 50-25 debate. There was also the fact that this is September, so it's the update from their June projections, the summary of economic projections. And one thing there, just going back to what you initially said, was you didn't think the Fed would live up to market expectations. So in the latest dot plot of officials' forecasts, most expect the policy rate to fall to around 4.25% to 4.5% by the end of the year. Market pricing is still though for 4%, so the market is still dovish. It's got a high dovish appetite, still remains.

Yeah, I mean, look, I don't know now. I'm gonna give up predicting what the Fed might or might not do because I got it wrong. This isn't the Fed I thought we had. So there's 2 meetings left before the end of the year. 4% by the end of the year would mean another 2 50-point cuts. I mean, that would be nothing short of sensational stuff. I don't know, if I was a betting man, I would bet that that didn't happen. I think go big early and then, right, let's do 25 cuts in the November meeting and then the December meeting, meaning we'll get down to 4.5%. But, but look, what do I know? It obviously depends on what happens with inflation and if that does— and the unemployment rate, that's it. They're the two games in town. Inflation, as long as it doesn't sharply drop— if it does sharply drop below 2%, well, wow, yeah, then actually you're going to see bigger cuts. Then it's going to be a— that's, that's a bad news story for stocks. Then, um, basically stocks will only lift and move higher off the back of rate cuts when we're confident the Fed are ahead of things and we're not going to get a recession. Any hint 'But actually, you know what, this economy is really slowing down faster than we thought.' Doesn't matter what the Fed do with cuts, you're going to see markets sell off. So it's really that underlying recession risk, along with what the Fed does, that really is going to govern how things move into the end of the year.

So the Fed so far are on top of things, soft landing, equities still near their all-time highs for now. Is that the summary?

Yeah, that's the summary. And I would say that the dot plot— so remember, this is their— this is the Fed's way of just every 3 months they give us an update on what they predict will happen in the future to interest rates. And so that right now the dot plot's around 4.5% for the end of 2024. So the Fed are telling us 2 25-point cuts, or it could be 1 50-point cut, right? But they're saying that's it by the end of 2025. With looking more like 3.25%. So that would be, yeah, I mean, that, that's, that's a lot, right? And actually that's come down. So that's one of the big changes in the Fed dot plot since they updated it from June, because in June they were predicting that rates at the end of 2025 would be above 4%. Now they're saying it will be more like 3.25%. So you've been at, you've seen a sharp downward revision to their end of 2025 forecast. Then it's pretty much not too much change, slight nudge lower on the end of 2026. And then interestingly, they have this thing on the dot plot, which is not only the end of each year what a rate's going to be, they have this thing called what, what will rates be in the longer run. And what they mean by that is, you know, what's the, what's the neutral rate, as we say, as in what's the perfect interest rate that will mean inflation stays at 2% and we get economic growth. And right now there's some debate as to what that might be. They've actually revised that up So that was the one sort of thing out of kilter here on this change in the dot plot. Whilst most of the end-of-year predictions came down, that longer run ticked up. So in June, and I kind of on average in June they were thinking 3, well below 3% was the neutral rate, but actually now it's kind of just at 3 maybe. Yeah, so it's marginally ticked up, but look, splitting hairs a bit here. Obviously the big news is the 50 basis point cut The Fed have gone, got, got the, got the bazooka out and Powell is not messing about.

Okay, he's not messing about. Andrew Bailey perhaps then a little bit more cautious, bit more gradual because one of the things you often talk about is interest rate differentials and sterling rose briefly hitting its strongest level against the dollar albeit temporarily since March 2022. So is that a case as well of that move more pronounced just because the context of what happened literally 12 hours before or so?

Yeah, so the Bank of England didn't cut when the Fed went big with their cut. I mean, the Bank of England did already cut once, um, remember at their previous meeting, whenever that was, in end of July I think, wasn't it? So they have already cut once and they're expect— the Bank of England are expected to cut at the next meeting in November. So if that happens, then, you know, by November both banks would have cut by half a basis point. But the Fed are going in bigger chunks here, so this has led to dollar weakness and it's led to sterling strength against that dollar. And we're up above 1.33. And so yeah, as you said, you've got to go back right the way to the start of 2022 here to find the last time we had the value of the pound this strong against the dollar. And yeah, it's all about that interest rate differential as we predict that the Fed are now going to be lowering rates faster than the Bank of England. The Fed seem to be more confident, they seem to be more, uh, their risk appetites may be a bit higher in terms of, right, let's— it's action. And, and the Bank of England are just a little bit more cautious.

Is there a difference at all in their general behaviors anyway? I'm trying to remember on the way up in rates, the Bank of England compared to the Fed. So is it unusual to be them different again on the way down?

No, I wouldn't say so. I mean, I think like out of the big three banks, the US, the Fed, and then the Bank of England and the ECB, you'd normally have it where the ECB are the most cautious, they'll go last, their rate changes will be smaller, they're very conservative. The Fed are kind of the opposite side, they're a bit more proactive, bit more gung-ho. And then you probably put the Bank of England in the middle of those two. So they were pretty aggressive cutting rates during COVID They were pretty aggressive raising rates during the inflation crisis, just a little bit behind the Fed. And yeah, I think this is eminently predictable. And you're actually getting— it's interesting with the HSBC was saying after the meeting, they predict now that the Bank of England will cut at every single meeting in 2025, every single one. And so they're a bit more— so HSBC have a more dovish expectation from the Bank of England than the market does. But that's for next year. But yeah, you'd expect that. I don't know, surprises this week from the Bank of England.

I think that was pretty much— just to be clear, when supporting HSBC's kind of statement there, the Bank of England did say it would take a, quote, gradual approach to loosening policy, assuming that there's no material changes in the economy. So that's what we'd call forward guidance, right? The green light that all remaining equal the cuts are coming.

Absolutely. And the Bank of England, they, they have their— they update all their economic projections and all the rest of it, um, in November. Um, the Fed did it this week, right? So they normally do this every quarter. It's the Bank of England are a bit out of sync with the Fed on that. So normally with the Bank of England, they like to have rate changes, um, at the same meeting where they're also updating us on their economic projections because they use that economic forecasting to explain why they've done what they have with rates. So they, they tend to like to do that. So again, not a surprise. Um, but maybe one, maybe one point back on the Fed actually, if you don't mind, because like, right here we are, big cut, okay? Markets are loving life. And so, you know, we've got 3 months left to go the year. So what's going to happen?

You know, hold on, hold on.

All-time highs.

Do I need to get your lawyer present before you make another bold claim here?

All I'm saying is, uh, as an analyst, as a trader, you know, you want to be— you have a view, right? And then which you trade. And then, right, what is it that I need to be monitoring? Um, where are my red flags that if this happens, then I need to change my view? So that happened to me this week. The Fed cut by more than I thought, right? Changed my view, right? Now, into the end of the year, I think we do— it's definitely about the unemployment rate is key now, right? And that's been going up. But I actually read a piece in the FT yesterday which was very interesting indeed, which was talking about, um, migrants coming over the Mexican border and how there's been a huge influx of, of migrants coming across that border. Now what does that mean for the labor market? Well, the labor market, the size of it has increased, and actually quite dramatically. The figure— so the Congressional Budget Office in 2023 estimated— so at the start of the year they estimated they reckon about a million new migrants will flow over the border, and that will see the labor force go up, right? At the end of 2023, they revised that figure. It wasn't 1 million, it was 3.3 million. Now, what does this mean from the labor— is this why the unemployment rate's going up? Because the labor force is increasing because of migrants coming in. The point the FT was making, actually, because of the swelling of the labor market, job create— we need more jobs being created to absorb the increase in the labor market, right? So when we look at non-farm payrolls In 2023, we have payrolls averaging at about 250,000 jobs a month, and back then we thought, wow, that's really strong, super hot, right, labor force is on fire. But actually, was it that that was the necessary amount to sustain, you know, as a neutral rate to sustain the increase in, in people coming into the labor market? The point is now payrolls are less than 100,000 a month. Now, is that really bad? Is that much worse than normally 100,000 a month because of this big spike in the labor force? We don't know. And so that's just something to monitor and watch into the end of this year. It— what, what happens with this unemployment rate, you know? And actually, migration, it is deflationary as well because you're getting migrant workers who typically earn less coming into the workforce. Okay, so companies are paying them less, and so this typically leads to deflationary— so yeah, I'm just saying, let's monitor, as always, let's monitor the labor market, let's monitor the inflation situation, and just keep a half an eye on that migrant number situation, which has really led to a spike up in the number of people in the workforce.

Anything to avoid a soft landing, you are, these days. I mean, it's a Friday, Piers, I know it's You know, pretty dull days, you know, end of summer and all, but I think I need to take you out for a pint or two and just cheer you up a little bit.

Well, final point, S&P all-time highs, NASDAQ, nope, not all-time highs. So again, it's quite interesting to, to see that the, the tech situation, which led the rally in the first half of the year. Tech has gone up, don't get me wrong, but the NASDAQ's not back at its summer high here. So again, you're seeing that, that kind of preference for non-tech sector companies, you know, as we see this, you know, bump higher off the, off the bumper rate cut.

All right, cool. Well, look, short, sharp episode just to round off the week. As a reminder, if you are a student and you're eligible within your academic cycle for internships for next year, Deutsche Bank, both in investment bank origination advisory, so classical banking, but also fixed income currencies, which is trading and markets, quant and tech data innovation. That's all open now, as has HSBC with asset management, global banking, commercial banking, finance. Check out the Amplify Me LinkedIn, you'll be able to get access to all of those particular links, but they've just opened. The past few days. As we always say, you got to get in quick. So check out some of the resources we put out.

You got to be in it to win it.

Exactly. All right, thank you as ever for your time, Piers. Have a great weekend, everyone. Take care.

Yep, see you later.