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The Asset Class with Alex Holroyd-Jones · Strictly Business

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