You're listening to Strictly Business Podcast with Lindsay Williams.
The US Federal Reserve is always in investors' spotlights, but it seems to me
more so at the moment.
And to that point, I received a piece of work from the desks of Alex Holroyd-Jones
and Rebecca Phillips,
portfolio manager and analyst, respectively, at 91 in London.
Let me just read you a snatch from that piece.
It says here, the Fed has flipped into risk management mode.
a subtle shift in language that carries major consequences for markets.
What looks like a technical recalibration is, in practice, a tailwind for equities,
said Alex Holroyd-Jones.
And he's on the line with me now.
Alex, as if equities need a tailwind, but you contend that that's what they're
getting.
I think that's right.
Yeah.
Thank you for having me.
Yeah, I mean, I think one of the big mysteries this year is why markets have
gone up so much when...
The risks seem so elevated and we're in what people expect to be a stagflationary
environment,
yet we can see equities going to the races.
And I think there are some important drivers under the surface which have
facilitated that.
And the Fed being one of them.
I think the Fed at the moment, after the recent release of the FOMC minutes,
the market's factoring in two more 25 basis point cuts this year.
Would you agree with that?
Yeah, I think that's right.
And I mean, When you think about that and you look at where inflation is, inflation
is above target.
You have people saying, well, why are they doing this?
But I think as we outlined in that piece, you know, there have been some changes
which are subtle,
but have meaningful implications that I think we're seeing playing out, which is
really, really important for markets on a forward looking basis.
What are the subtle changes of which you speak?
So I think we go back to earlier this year.
When you think about the environment we had, we had the tariff shock.
And that led to materially higher risks of stagflation.
I think the markets triced that in.
We saw the trapdoor open under markets in April.
And then since then, I guess markets have recovered.
But the Fed were at that point worried about inflation, which is right, because
as we know,
when tariffs go on on your imports and prices are going to rise.
And I think the Fed were, to some extent, worried about prices.
and weren't able to adjust their policy for the growth shock that was coming
because the tariff hit.
And as a result, that was arguably not a good environment for markets because the
Fed weren't able to ease,
constrained by higher prices, and the growth data looked pretty bad.
But we fast forward to where we are today,
and I think one of the key changes was that we saw actually weakness in the labor
market.
Conversely, that turns out to be pretty good because the Fed at that point would
say,
OK, well, actually, maybe we have to take our policy looser to try and guard against
the risks that
actually the labor market starts turning over more materially.
And that's a big change because we find ourselves in this environment where, yes,
prices are high,
but the Fed are looking at these labor market risks.
And at the same time, there are signs of the growth picture.
beginning to bottom out.
So you went from a situation where the Fed weren't helping markets to now they are,
and that's a big change.
You're sort of subtly saying, there's that word again, subtle,
you're subtly saying that the Fed is prioritizing the employment situation over
inflation,
because in them, again, referencing that FOMC minutes statement, which was recently
released.
They said they want inflation back at 2% and they want the employment market
buoyant.
It seems to me, again as a layman, that there is a case of wanting their cake and
eat it.
I think that's very fair from an outside perspective,
but I think you have to understand exactly how the Fed potentially set their policy.
And I think this is, it's not necessarily right, but it's how they work.
And I think the key point there is that they look for evidence that their policy
is either loose.
or tight.
If they can see evidence that policy is loose, then they would seek to potentially
tighten.
And if they see evidence that policy is tight, they would seek to loosen.
And one of the key, if not the key element of that is the labour market.
So the current inflation rates may look high, but the way the Fed will work is
they say if the labour market is deteriorating,
then in the future, inflation will be lower.
And early this year, there was no sign of the labour market deteriorating.
If you remember, we had all these NFP prints which are still coming out and the
labour market prints are still coming out very, very strong.
And then fast forward to where we are today, those labour market prints are now
at stall speeds,
so coming out close to zero, which reflects all of that uncertainty that
we've seen.
But in the Fed's mind, they will be saying, well, now we can see evidence that
our policy is tight,
and therefore we have to loosen.
And that's a big shift.
And if that's happening whilst the growth environment is looking like it might be
basing out as the tariff uncertainty falls,
as financial conditions loosen, as lower interest rates start to impact the
economy, then that's
essentially becomes the best environment for risk assets because you have a
proactive central bank and a growth
picture that's actually looking a little bit better.
Okay, so let's say we get two cuts this year, 25 basis points, 25 basis points,
and there's a sort of a melt-up in equities if they haven't already factored
those two cuts in, of course,
because that is also something that could happen.
But what about next year?
A lot of people say, Alex, that the tariff situation...
It's all very well now.
It doesn't seem to be impacting inflation that much.
But that's because the importers and the people that are affected by the tariffs
are absorbing the tariff
increases at the moment because they can.
But later on, maybe in the first, second quarters of next year, they won't be able
to absorb that and they will pass it on to the consumer.
And therefore inflation goes up.
And then the Fed have got a problem because people will moan ahead of the
November elections, 2026.
Yeah, I think that's a really, really interesting point.
I think first and foremost, it's important to note that the market and expectations,
and I include the Fed in this,
had already moved to think about there being a stagflationary hit.
So to some extent, it was somewhat discounted.
And as you said, ultimately, we've been through a period where actually those
outcomes have been less bad as initially feared.
So prices have actually been less acute.
And to some extent, that is allowing the...
the Fed to ease.
And that's one of the reasons why ultimately, if prices are less bad,
then they can provide liquidity and not be too fearful about it leading to further
price rises.
But I think, as you say, the big issue potentially comes next year, because
ultimately, this is a price shock.
It might be less truncated than feared, as a result, more protracted.
So it takes time for this to filter into prices.
And the market still expects it to be temporary.
So I guess the big risk next year.
which is most certainly at the forefront of our minds,
is that actually prices remain stickier than us and
the Fed fear.
And that means that maybe the Fed are forced to be less accommodative next year.
But what I would say, I keep coming back to is in the short term, we're talking in
the next three to six months, you have a Fed which is
trying to guard against those labor market risks and is trying to provide liquidity.
And you already mentioned it, we have, to some extent, the ingredients for a melt up
in stocks,
because you have a life changing technology in AI, you have a growth
backdrop,
which looks like it's basing out and picking up and you have liquidity entering
the market.
And so in the short term, the next three to six months, you have this very, very
positive environment for equities.
And next year, I think that's where potentially it becomes more challenging if
those price pressures remain stickier,
which has to be a real risk.
OK, let's take the actual data, the hard data out of the equation now.
And you very neatly avoided politics in your piece, you and Rebecca, Alex.
I don't know if that was because of politics are even more erratic than data
is.
But there is there is an element of truth to the fact that the Fed without power
will.
feel compelled to cut rates because of you know who absolutely i think that's a it's
a really important point and it's most
certainly something we think about so i mean as as the listeners will be aware i
mean next year we see powell is likely
to step away from the fed entirely obviously we're going to get a new chair
and
there'll be a number of appointees who are going to be appointed by trump i think you
know ultimately there is clearly a willingness and
a desire from the administration to see interest rates fall.
to potentially support growth next year.
For now, these demands for lower rates are not necessarily an issue for markets.
And the reason being is because of those points I raised earlier,
which is that policy is deemed to be tight because we can see that the labour market
looks soft.
The issues for markets will become next year if you have a new chair and new
members
of the board who are calling for cuts.
If growth was looking very strong and prices were rising and they were still
calling for cuts, that would become an issue.
But for now, it's less of an issue because the economy
is looking like it needs stimulus because of that labour market weakness.
So it's a risk next year that potentially you see independence come under question
from the Fed.
But at the moment, there doesn't seem to be much in the way of an issue with what
some of those more dovish members are saying.
Yeah, I wonder what will happen if the government continues to be locked down in
the United States, because we can't get the non-farm payrolls numbers out.
I'm sure that the Fed gets them under the table.
But anyway, we've still got the ADP numbers.
That's the private sector.
employment numbers every week.
So we'll get a better picture with a couple of sets of data, I think.
Now, on that point, what about your view, Alex?
Is it going to be a melt up or at worst,
a steady momentum of the bull market that has become so familiar to us since the dip
in
April of this year?
It's something that we continue to think about how far markets can potentially run.
And I keep coming back.
to and you mentioned the labour market, I keep coming back to the labour market and
I think it is ultimately the most
important indicator to watch for a number of factors.
One is that we know to some extent it's lagging in that firms
don't make decisions immediately,
it takes time and what we are seeing at the moment is an echo of all of that
uncertainty that was around
earlier this year.
And so the labour market that looks soft, we saw the ADP numbers were very weak in
particular, the private sector job numbers looked very weak.
But ultimately, it reflects where we have been.
And as a result, those numbers are likely to look soft for a while.
But what that means is the Fed are going to remain accommodative as long as their
numbers remain soft.
And as I mentioned, that gives a window of three to six months where Potentially,
we still see the uncertainty from early this year continuing to weigh on those
employment decisions.
And that allows liquidity to remain abundant.
And whilst liquidity is abundant and you have a growth picture which holds up,
then the markets can have the potential to run quite hard.
And I keep coming back to the fact that we're in an environment where fiscal
policy looks quite loose, particularly in the US,
but globally.
And you've got interest rate cuts.
and that Combination is pretty rare outside of recessions.
And so you can see why we have the ingredients to see the market continue to
move higher.
But what I would say, and what I'm not downplaying, is the fact that the labor
market does clearly look weak.
And while it looks that weak, there are the risks that it deteriorates further.
And that's a risk that we continue to be acutely aware of.
But for now, you're in this Goldilocks-type environment where growth
is strong.
and the Fed are supporting it.
And that's a pretty bullish environment for markets.
The trend is your friend, as someone wisely said many, many years ago.
What a complicated situation.
But it will be less complicated once the Fed and the markets themselves do their
own thing.
Alex, thank you very much for your analysis.
That was Alex Holroyd-Jones, Portfolio Manager at 91 in London.
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