Central bank lookahead

SPEAKER_1 (0:01)

Bonds are back.

And so is All the Credit, P. Jim Fixed Incomes Monthly Podcast Series. From the latest trends to long-term perspectives, you'll get timely fixed income insights from leading economists, research analysts, and investment professionals. Whether you're new to bonds or a seasoned investor, tune in to All the Credit wherever you get your podcasts. This podcast is intended solely for professional investor use. Past performance is not a guarantee of future results.

Ethan Wu (0:36)

Thank Pushkin.

For the better part of two years, as central banks have been raising rates, it's been all about getting inflation back down. But now, across the developed world, we're entering a new phase of the central bank fight. Inflation has come down in England, in Europe, in the US, and central banks have to start to think about how they're going to deal with crunch time. This is Unhedged, the markets and finance show from the Financial Times and Pushkin. I'm reporter Ethan Wu, here in the New York studio, joined as ever on Tuesdays by Marcus editor Katie Martin.

Katie Martin (1:12)

Hey, Ethan, are you pumped for Fed Day? Are you excited?

Ethan Wu (1:16)

I'm so pumped.

Every Fed Day, I roll into the office at a cool 1:30 p.m. because the press conference doesn't start till 2.30. Statement doesn't come out till 2.00. I take the morning, I relax, and then it's an insane crunch for the rest of the day. It's absolutely so stressful, but always a good time.

Katie Martin (1:33)

Happy Fed Day to all, all who observe.

Ethan Wu (1:37)

Always a good week to watch Central Banks. This week is especially interesting. We had a great splash in the FT a couple of days ago titled, Central Banks Prepare to Rebuff Investors Over the Path of Interest Rates. Sort of spelling out the fact that markets see interest rates falling next year. Central Banks aren't quite there yet.

But I think the piece highlighted a really important dynamic that we should talk about both as the Fed, ECB, and BOE meet this week, and as we go into 2024

It's a new game for Central Banks. They have to start thinking seriously about whether interest rates fall, how fast they fall, what should trigger them to fall. That's now a live discussion very much in the market, and also I think increasingly among Central Bankers and economists too.

Katie Martin (2:19)

Yeah, this is a very delicate juncture for big Central Banks. And as you say, we've got the big three, the Fed, the ECB, the Bank of England, all coming up this week. Bank of Japan, just before Christmas. Always watch out for the Bank of Japan. But anyway, that's a whole other story. We've got the big three this week. And yeah, the market is doing some weird stuff, right? So the market is effectively saying, hooray for the Fed. They've somehow engineered this situation where they've raised interest rates really, really aggressively, and they haven't like nuked the economy.

So they're saying soft landing, everything is good.

But at the same time, if you look at where rate expectations are, it looks like the market is expecting quite a lot of rate cuts from the Fed.

Like 100 basis points or so, that's a percentage point in real money. Over the course of next year, that's a lot, you know, by sort of historical standards. So these things can't be right because normally it would only be cutting interest rates if the brown stuff had hit the fan, whereas the market is saying everything is fine and they're still going to cut rates. So the Fed now has to, well, doesn't have to, but the pressure is to give some guidance to investors about what is going to happen next. And the danger is that if central bankers say, look, have at it, we're going to start cutting rates before you know it, they wouldn't say that in so many words, but that sort of thing, then the markets will go gaga, bond yields will fall really fast, stocks will rise really fast. And then guess what? You've got the inflation problem back that you thought you'd defeated. So really delicate time here.

Ethan Wu (3:55)

Absolutely. Markets are forward-looking. It's kind of a cliche to say, but it's really important in this context because even without central banks, really saying tons about how or whether interest rates will fall next year, you're already seeing markets price it in, like you're saying, Katie, just looking really at the economic data and not at what central banks are saying. So then you can imagine if they actually actively started talking about interest rates cuts, markets would absolutely lose their heads.