Stay informed with free updates
Simply register at American economy myFT Digest – delivered straight to your inbox.
This article is an on-site version of our Unhedged newsletter. Premium subscribers can sign up here to receive the newsletter every weekday. Standard subscribers can upgrade to Premium here or explore all FT newsletters
Good morning. Ethan here, with some professional news. After two and a half years, here is my latest edition of Unhedged. During that time, Robert and I had some great interviews, some good calls, some disastrous calls, a bear market, two bull runs, and tons of great reader letters. Writing this newsletter has been a privilege and I will miss it.
Later this year, I will become Asia correspondent at The Economist, where I will be based in Singapore. Rob leaves next week to meet central bankers in Switzerland; Unhedged resumes normal service at the end of April. Today, some parting thoughts from me. I won’t be on FT messaging for much longer, but I would like to hear from you on Twitter or LinkedIn. Or email the big man himself: [email protected].
The world has changed a lot
When Rob Armstrong hired me in November 2021, interest rates were at zero, inflation was over 5%, the S&P 500 was at all-time highs, 100,000 Russian troops were massing on Ukraine’s eastern border and I was a recent graduate in economics. take all this into account.
We saw the world changing, even if it wasn’t obvious at the time. Jay Powell’s Federal Reserve hesitated to raise interest rates until it had no choice but to act. In late November, Powell told the US Congress that it was “probably a good time to abandon” the idea that inflation was “transitory”. It was the end of my first month, when one of our main concerns was whether my wardrobe was stylish enough to be reviewed by the FT’s chief menswear critic. It was also the start of a new regime – cemented when, on February 24, 2022, Russia launched its full-scale invasion of Ukraine. The night of the assault, Rob was off work and I wrote one of my first solo newsletters, four months into the job. The feeling of being thrown in at the deep end was overwhelming. But it brought me a sense of relief; I was far from the only one overwhelmed by events.
The world that American investors face today is very different. But the key question is whether we will return to the old status quo. Rob and I constantly struggled with this. I believed that the old world would eventually return. The fundamental forces behind low and falling interest rates were, in my view, powerful and enduring: population aging, low productivity growth, inequality, and high demand for safe assets (better known as “global savings glut” by Ben Bernanke). The pandemic was a significant but, in a word, transitory shock.
Today I would take the other side of the argument:
-
Since 2021, US interest rates have risen more sharply and for longer than expected. When the consensus is repeatedly wrong in one direction, that tells us something.
-
Long-term market expectations have come to recognize a regime shift. Large-scale measures, such as the 10-year/10-year forward swap rate on inflation-indexed Treasury bonds, provide a sense of the market’s view of long-term real rates. On this level, we leave the 2010s behind us:
-
Rates will only return to 0 percent in the event of a real crisis. Demand is healthy again, thanks to a tight labor market and the consumption it supports. Inflation is not meeting any forecasts, but overall it appears to be falling slowly.
-
American authorities have become better at managing the financial system. There has been more thought about it since 2008; today you can earn a master’s degree from Yale in systemic risk studies. Practice helps too. The repo market, the heart of the system, was rapidly defibrillated in 2019. The Fed’s alphabet soup of pandemic liquidity facilities was staggering in scale, and the Silicon Valley Bank cleanup shows just what regulators can do even without a full-scale crisis. The banks’ term funding program amounts to a 200 basis point rate cut injected narrowly into the banking system, according to JPMorgan’s Bob Michele. The fact that such precise intervention is not only possible, but well planned, should reduce the need for future emergency rate reductions.
-
The bullish productivity argument has never been stronger in 30 years. New business creation exploded after the pandemic and never fully receded. Tight labor markets improve worker-employer matching. The political will to invest in public R&D has materialized. Private investment in innovation could follow suit: S&P 500 investments have increased and U.S. manufacturing capacity is growing at the fastest pace since 2008. Long-term economy-wide measures of R&D have jumped:
-
Both parties now take on a greater role for government. The proof is simple: the United States records historically high procyclical budget deficits outside of a war. This is because political attitudes towards spending have changed, justified by the conflict with China, without attitudes towards taxes being offset. Ten years ago, after a sluggish recovery, the United States managed to reduce its deficit in a bipartisan manner. Today, after exceptional recovery measures, the country is pursuing a bipartisan industrial policy.
-
War and climate change mean that supply-side stagflationary risks always remain in the background. Self-serving explanations of the “great moderation,” the period of economic calm between 1980 and 2007, suggest prudent management. The most compelling story is one of a favorable external environment – in other words, good luck. It seems he’s exhausted.
I think we’re starting, rightly, to look at the 2010s as an abnormal period in which real rates were lower than healthy. The fundamentals of low rates are still there, but if you squint, there are signs that they are easing. In terms of demographics, a massive global migration towards rich countries is underway. The recent experience of the United States, where a massive wave of people crossing the border ultimately kept the job market going, shows that aging societies are not doomed to shrink if they let people in. especially finish. Finally, sustained fiscal spending could ultimately generate more supply of safe assets, thereby absorbing excess savings (at the risk of a debt crisis).
This does not justify a dizzying rise in American rates. But there is enough evidence to believe that interest rates, after decades of structural decline, have reached a bottom.
Of course, the real answer is that we don’t know. This is what I appreciated most about Unhedged: the space for reflection alongside a community of generous, engaged and intelligent readers. The ability to test an argument one day, be wrong, and write down why you were wrong the next is invaluable. Few errors, factual or analytical, escape the attention of Unhedged’s audience. So thank you for the many emails and comments you have sent us over the years. If this newsletter was half as edifying for you to read as it was for me to write it, I would consider it a great success.
A good read
From the archives: is irony a cause or a palliative for British decline?
Uncovered FT podcast
Can’t get enough of Unhedged? Listen to our new podcast, hosted by Ethan Wu and Katie Martin, for a 15-minute deep dive into the latest market news and financial headlines, twice a week. Find previous editions of the newsletter here.
Newsletters recommended for you
Swamp Notes — Expert insight on the intersection of money and power in American politics. register here
Due diligence — News from the world of corporate finance. register here