Is Fed policy working?

SPEAKER_1 (0:00)

What we want to maximize is not expected return, it's not expected wealth. It's some kind of risk-adjusted wealth or risk-adjusted return, and we all know that, but we have to be really careful that we don't fall into a trap of maximizing expected value or expected money or expected return.

SPEAKER_2 (0:20)

To hear more about managing risk in the face of uncertainty, subscribe to P. Jim's The Outthinking Investor in your favorite podcast app.

Rob Armstrong (0:36)

Pushkin.

It was almost exactly two years ago this month that the Federal Reserve started increasing interest rates. But inflation is still above the Fed's target and appears to be rising rather than falling. Today on the show, is Fed policy working?

This is Unhedged, the FT podcast about markets and finance. I am Rob Armstrong, and I am joined here at Unhedged World Headquarters in New York City by Kate Duguid, who is our expert on all things, bond market, treasury, Belgium. She grew up in Belgium, listener. So she's a woman of all trades.

Kate Duguid (1:28)

Hello.

Rob Armstrong (1:29)

Kate, let's talk about the Fed meeting yesterday, the statement in the press conference. What did you take from that?

Kate Duguid (1:36)

So the Fed yesterday signaled that interest rates are going to remain higher for longer. The FOMC, or Powell specifically, said that there had been a lack of further progress.

Rob Armstrong (1:47)

That was the key phrase, lack of progress. It brought me back to my report cards as a child.

Kate Duguid (1:55)

I doubt it.

Rob Armstrong (1:57)

You'd be surprised.

I was a late bloomer. I was a late bloomer. Anyway, so lack of progress was the headline.

Kate Duguid (2:05)

On 2% inflation, or towards 2% inflation, yeah.

Rob Armstrong (2:08)

Yeah, and we're broadly, we're at three, and maybe go in the wrong direction.

Kate Duguid (2:12)

So it's not actually a lack of progress, right? It's that we actually have gotten worse. Things have gotten worse, right? In terms of inflation in the past three months.

Rob Armstrong (2:21)

Right, maybe it's not a huge move, but the lines seem to be going in the wrong direction. Do we have a diagnosis for why that's happening?

Kate Duguid (2:28)

People have attributed it to housing, right? That's the stickiest part of things.

Rob Armstrong (2:31)

Yes.

Kate Duguid (2:31)

I mean, in headlines, certainly we've had some stuff with oil, which has driven things, but who cares about that?

Rob Armstrong (2:37)

Yeah, we only care about core inflation. That is inflation without food and energy.

There was at least one question in that press conference that suggested the Fed itself was part of the problem. Somebody stuck up their hand and said, Mr. Powell, aren't loosening financial conditions contributing to the strong growth that is fueling inflation? And I think what that reporter was referring to was the fact that back in December, the Fed came out and said, oh, we think we're at the peak for the cycle and the next move is gonna be down and et cetera. And that got markets so excited that that itself was inflationary. How do you like that theory?

Kate Duguid (3:16)

I like that theory.

If you take a look at the financial conditions index, certainly financial conditions have gotten a lot looser since October, but the moves have not been like huge, right? Like we've actually been kind of stable in the past couple of weeks. I don't know, there's been a little bit of variability there, but I'm not sure. I would say that the thing on financial conditions is just, I mean, it's all driven by stock prices.

Rob Armstrong (3:39)

Yes, we should maybe back up for listeners actually. Financial conditions index is basically how easy is it to get and move around money.

So it's like stock prices, credit conditions, how easy it is to borrow.

Kate Duguid (3:57)

For companies.

Rob Armstrong (3:58)

For companies, specifically.

So generally when there's optimism in the air, financial conditions loosen because if you need funding, if you're raising equity, whatever, it's like free playtime. People wanna give you money.

Kate Duguid (4:14)

Yeah.

Rob Armstrong (4:14)

Right? And so the question is, did the Fed, by broadly signaling a few months ago that the next move was lower rates, kind of release these animal spirits in some way?

Kate Duguid (4:25)

On the one hand, you could argue that they did, right? Because you've seen a bit of a move in this financial conditions index, which should describe pretty broadly how easy it is for a company to borrow money.

But rather than just looking at borrowing rates, these financial conditions indices really include a lot of stock, but a lot of it is made up by stock prices. And the ease with which companies can borrow has actually not changed that dramatically. But there has been a real rally in stocks on this expectation that rates will be cut.