Unhedged Live: How Katie was “right all along”

0:00Hello and welcome to the On-Hedge podcast live from the FT Weekend Festival in London with me Katie Martin and him Rob Armstrong. Yeah! We've been let out for good behaviour again. Normally we record this podcast in something that looks a little bit like a grey padded cell, mine in London, you're in New York, but now if you're listening to this podcast just imagine we're in a white marquee in the grounds of Kenwood House, it's a beautiful day in London and there's loads of people here and dogs. So a few weeks ago the organisers were like on my case saying what's the title of the event? What are you going to talk about and you were like on holiday or couldn't be bothered to reply or something? Something like that, yeah. I was like well I don't know, it's like three or four weeks away, like how am I supposed to know what's going to be happening in three or four weeks. But then a glorious thing came out of the sky which was a column written by Rob Armstrong that effectively said Katie was right and I was wrong all along.

1:13So let's... That's one interpretation of what the column said. So I've been banging on ever since Trump came back into power, I've been banging on about this idea that investors are thinking differently about US markets, it's not the kind of safe place to be, that it's always been treated by investors and you've always said pipe down young lady, nothing will happen, and now you're warming to the idea that I'm onto something. I am, but I would like to clarify, there's two parts to that thesis that it's all going to be fine from an investment point of view in America. Point number one is that America has the strongest corporate economy in the world by a mile and matched to the deepest capital market in the world. And politics doesn't change that. The companies are bigger, they have a large domestic market, you can list their virtues, there's a deep stock market, there's plenty of financing, there's loads of entrepreneurs, there's good universities, it's everything you want. So that's the positive part of the thesis, is money will always come to that corporate slash financial monster that is the United States.

2:19Part number two is the thesis, is no matter how bad it gets in the United States, it'll be worse in the rest of the world. And those two points are kind of causally connected, you know, it is a US sneezes, rest of the world gets a cold kind of problem because the dependencies fail. I think all of that remains broadly true, where and saying this makes me feel like I'm putting hot coals in my eyes, you turn out to be right. Is that you can put that said risk if you borrow like a total crazy person both on the corporate and the government side. And I think that can destabilize the American system enough, that all this good stuff that isn't changing can be kind of knocked away. And so we have a runaway government deficit and debt that for reasons no one quite understands, the market is just noticing now. It's like hello, we've been watching this show for 30 years, but they're paying attention.

3:21Plus we have the explosion in debt from our most important companies, AI companies, and between the two of those, they're kind of connected, it's this huge blob that could ruin everything. That's a short version of me conceding that you are writing about something just this one time as the exception that proves the rule. So you're sort of awakening to this idea that there may be some sense in putting money to work in places other than the United States for America. By the way, I do have money at work in other places myself. I'm not totally against diversification. But still. So you're thinking about it from a kind of sort of numbersy point of view. You're thinking about debt levels. I'm thinking about institutional credibility, which I think is a much more important part of that equation. So let's talk about a thing that happened last week, which is that the Dutch central bank, so you have like the European central bank, but you still have national central banks across all of the euro system countries. The Dutch central bank said that it had brought back its gold from New York. And it said, you know, it didn't just say this is just a thing we've done on a whim. They said it was all about the kind of trade ability of the gold, but they said we're doing this due to geopolitical concerns.

4:32And effectively, they think their gold is safer in London than it is in New York. So they brought over 78 tons of the stuff. Yes. They've switched from New York to London. Now that I think in a very kind of like dry Dutch finance, he kind of way is saying, we don't trust you guys. Like the whole point of having all this gold is that in some sort of nightmare situation, the shit hits the fan, we need the gold. And now we're starting to wonder whether in that situation with the brown stuff hitting the fan, you would give it back to us. Back to us. Right. It is ours. Yes. And that I think is a red flag. Yeah. I think that's true. And looking into the minds of the people who made that decision, what percent chance that the US will repossess your gold from the Netherlands? The gold from the vaults beneath New York City? Do you have to arrive at before you decide to move it? Because it's expensive to move gold, heavy stuff. It's a big deal. It sends a message to the US government that they probably hesitated to send in a lot of ways.

5:37So is one percent chance of repossession of global assets enough to make you that decision, two percent chance? So we're still my point being, we're still at the tail end of the risk distribution here. Even if you think there's a low chance, something you're really going to get awful in New York, that's a move you might make. But it's important, and I agree with you. It's a moment. It'll be interesting to see if others follow. Yeah. But it is just that way that very serious people have of saying, I think you've got an institutional credibility problem. And I think it's a problem potentially in a horrendous situation. It's a problem for me to have my national money in US assets and physically present in the States. And so scared that I'm going to move the gold to a country that might be run by Nigel Farage. Yeah. Yeah. Yeah. Exactly that. Yeah. So yeah, it's a bit of a kind of marker of where we've got to on this. The thing that I will definitely concede to you, Rob Armstrong, however, is that the US economic machine, this damn thing, you cannot knock it down.

6:44So just the other day, we had US non-farm payrolls data, the big kind of employment report, it's the number one most important data release in the global data calendar. And in the previous month, it had said, shockingly, that the US economy had lost jobs. It had lost about 20-something thousand jobs in July. Now they put their numbers out for August. And they said, first of all, oopsie, we made a bit of mistake in July, that it didn't actually lose 20,000 jobs. It gained 20,000 jobs. That's not unusual because data revisions are a thing and it's boring. 20,000 and it's tiny number. Yeah, yeah. But they also said that in August, the US economy added 162,000 jobs. And that's you have to remember the context for that number, again, in a country of 300,000,000, 160,000, not very much. But remember, you're talking about a country where the working age population is growing by zero or shrinking. And the participation rate is already very high. So you're adding jobs to a market that was already tight.

7:49And furthermore, it was incredible to see where those jobs appeared. It was in place like construction, restaurants, transport. So areas where it's cyclical, it's not the government, it's not schools, it's like economic activity, sensitive sectors added those jobs. So again, in a country that's not growing, it's working age population, it was a very impressive number. Love to say one month is just one month or as I abbreviate it, Ami-Jom. Ami-Jom? But it was a good month. And if you look at the long trend of that data, job creation since the pandemic has been going like this. It's a podcast, people listen to it, you can't do this. This is charts on the podcast. Line going down, line going down. And we get to about the middle of last year. And this starts to happen in the US economy. What does? You have to say it out loud. This is job creation. It comes back up again. If you're listening at home, I'm sorry. Charts on the radio. Charts on the radio everybody.

8:50So the US economy is firing on all... Yeah, and I've heard this canard repeated by colleagues I won't mention here at the festival. Without AI, America would not be growing at all. And that is... I mean, we would be growing a lot more slowly, but it would still be growing. There's more to American growth. So that sort of equity side of the story, the American companies are very strong and reporting high profits. That part of the story remains in place. The devil's on the debt side. Yeah, okay. Yeah. We'll talk a little bit about that in just a second. But... So you've got this situation where you've still got inflation that's somewhat above target in the States. I think it's been above target in the States for about 20 months. Yes. It's not working its way down either. It's not working its way down. You've got a jobs market that is on fire. It's doing great. So there's 162,000 numbers well above what economists have been expecting. So all things being equal, that says that later this month, September, the Federal Reserve under the new chair, Kevin Walsh,

9:56should be raising interest rates. Yes. Now then, do you think Kevin Walsh has got the balls to raise interest rates two months before the midterm elections? Yeah, it's a terrific question. How many people are regular listeners to the show just to get a sense? Okay, so I will still bore you with things you've already heard. Welcome to my world. I mean, there was this, the first two public appearances of Walsh and he was ambiguous. Yeah. And, you know, it's okay to say nothing. It's okay to say something. It's okay to say a whole range of things. But don't leave people wondering what you just said. And that's what he managed to do in his first two meetings as Fed. Then he comes out the other week in Jackson Hole and he's very clear. And he makes a hawkish noise. I don't know what this noise hawks make, some kind of screeching noise. He makes a hawkish noise. He says, inflation is too high and it's not getting better. I don't see any improvement in the data. And, you know, it was like big hawkish noise.

10:56Yeah. Right? So question number one, did he already paint his way into a corner? Yeah. Right? He came out his third meeting. He's still learning how to talk to all of us. Did he come out in his third meeting and make a mistake and destroy all his optionality? You know, when you're the chair of the Fed, you always want to leave a little back door open to whatever you said before that you can slip through at the last moment and change your mind. Which is a point he's actually harped on. The reason he doesn't want to talk very much is because he doesn't want to pre-commit to any course of action. He's rattled on a great length about this. I want to maintain optionality. I don't want to give forecasts to the future because forecast trap us. Yeah. Well, did he give a forecast by mistake talking in Jackson Hole and making a screeching hawkish noise? Yeah. Is he trapped? That's question number one. Is he trapped by his own words? Because now, if he doesn't raise, he just like tattoos wimp on his forehead in great letters, right? And that's a bad look. That's constant question. Because if we know he's a handsome man and it would be a shame. Oh, he is a handsome man. I will say, putting my fashion, he's got very good suits as well.

11:57We're not here to talk about your fashion collar. So you've got all these kind of investment banks that had been saying, look, I don't think the US is going to raise interest rates this year, 2026, and probably not into 2027 either. Now all of a sudden they're saying, yeah, I think they go in September and I think they go in December and I think they go in March. Yes. With like quarter point raises all the way through. But Donald Trump, for it is he. He said on truth social after the job's numbers, he said something like, the Federal Reserve with his new gera's got to get smart. And he said, lower the rate or I'll stop trading with countries with which we have a deficit. Now Rob, one thing that I love doing on this show and that you hate me doing on this show is when I ask you to account for stupid staff that Donald Trump says, nonetheless, please make it make sense that he's threatening trade tariffs if they don't. I mean, he just pressed the button on the Donald Trump word generator.

13:00Yeah, it's like, tariff's lower the rate. That's a leap. So I will not try to explain that, but I will go on my usual tirade. Others in this audience may feel differently. You may feel differently. I think the chair of the Fed has very little fear from the president. He tried to intimidate the last guy and it really failed. Trump is a wasting asset with two years to go. I don't say that anything about Trump in particular. That's just last two years of his second term president. You know, worse can look into the future and see Trump's power sliding down. So nothing to fear there. One of the main tests of his chairmanship is going to be a kind of guy who stands up to the president. So I think he has everything to gain by not doing what the president wants him to do. And if I had to assess that tweet from the president, I would say it made it materially more likely that the Fed will tighten. Because now they have to prove that they're not listening to the president.

14:00Well, yeah, so do they have to do what is it that TS Longboard is calling it? Like a credibility hike. A credibility hike. Like they have to hike now just to show that they can. Right. And this sounds childish. It is childish. Right. It's people playing chicken. But the crucial thing to understand about central banking is that perception is reality. Yeah. The reality of what central banks do is way less important than what central banks do. Right. And so it's important when the president tries to humiliate you that you push back. Because that creates that powerful facade. Yeah. And so I think he really has no choice. Although we have the strange case of Governor Waller. The strange case of Chris Waller. Chris Waller. Who when he was trying to get the job as the Fed chair was like, yeah, we should cut rates really, really fast. Yeah, yeah. And then when he was out of the running, he's saying, actually, I'm not sure we need to cut them now. And then he changed his mind again last week and said, we need time. He's a very influential governor. And I don't know, is he trying to give Worsh cover so he can cut?

15:01Yeah. But he came out and said, I don't think we need to cut right now. But it is hard to remember when you are talking about the God-like chair of the Federal Reserve. It's not up to him. That he's just the head of a committee. Yeah. And he has to have the persuasive power to bring people along with him, which is again a test for the institution. If the world perceives him as a Fed chair who cannot gather in the sheep and lead them wherever he needs to go, that weakens the power of the institution to control inflation. Yeah. And then he's going to affect the economy and so forth. So it's a weird, you know, he used the phrase, I used the phrase first, by the way. Oh, yeah. But he used Worsh in his speech in Jacksonville, used the phrase, Hall of Mirrors, to describe the game that Fed plays in Martin Luther. Are you claiming credit for Hall of Mirrors? No, but I had a call with the title, the Fed's Hall of Mirrors. And then the Fed chair says, Hall of Mirrors, how am I supposed to understand that? Well, so Rob Armstrong is directing Fed policy, what do you mean?

16:01Yeah, and that's basically that's how this works. Okay, fine, terrifying. So this whole will they won't they on the rates ahead of the midterms, which I take your point that I think. Due to, by the way, I should challenge you before you say it, let's have a bet. I think they're going to hike, what do you think? I think they're going to, so do I. So it's not much of a bet. Yeah, yeah. I think they'll swap viewers. I think they'll do like, yeah, a quarter of a percentage point. But I do think that the fury that will come from the White House as we get closer to the midterms, if he feels like people are blaming higher rates for any kind of little bump in the road economically, I just wouldn't like to be in more shoes, basically. Okay, speaking of shoes, let's talk about besenced shoes. Okay. I have never looked at its shoes, but I'm talking metaphorically still. So Scott, the secretary of the Treasury. Yeah, his shoes, you say? So, to speak schematically, the chair of the Fed, their problem is the short end of the interest rate curve. The problem of the Treasury Secretary is the long end of the interest rate curve.

17:02Yeah. So you're setting short term monetary policy here. The Treasury wants the long term rate to go down. You can summarize the job of the head of the US Treasury as funding the US government. Yeah. And he wants to do it as cheaply as he can, that's his assignment. So he wants that rate that 10 years and out to go down. Yeah. That's his job. Now, the deal has come down. He wants to lower borrow and cost. In his heart of hearts, does he want the Fed to... Oh. ...set Barkley? No, that's... No, it's one of the...it's a different dog. Barkley is somewhere and will bark. Yeah. For the long end to come down, does besent want wars to hike or to cut? And I think in the dark heart of Scott Besen, he's not rooting for Trump. He's rooting for wars. Raised rates at the short end established the credibility of the United States. Long end financing will come down. Scott Besen was on some podcast with Steve Bannon the other day, being mean about the FT and saying we're anti-American and awful.

18:04And so that's us told. Okay. Again. Yeah. But actually, let's just pause on that point about the bond market because it has been getting absolutely hammered recently. And the world can't settle on an agreed explanation for what is going on here. Like, either it's the market saying growth is going great, which in fairness, the payrolls data does just that, might be right. In America, the growth is pretty. Or it's saying the US is borrowing too much damn money. The national debt is already over $40 trillion. Yeah. Or it's saying... The Fed is not credible. The Fed has lost credibility. Or it's saying some sort of combination of those things. It's like... There's all these sort of explanations that cancel each other out. And I just don't know where we get to on it. I think the minions of the Trump administration, Moran, for example, says it's growth. Yeah. Growth in America is very strong. Of course, that's what long-term rates are telling you. Yeah. You said something different a month ago, whatever.

19:04I will agree with the Trump administration. Growth does have something to do with it. You have whatever, three to four percent GDP growth maybe last quarter. You have three percent of inflation on that. You have six or seven percent nominal growth. You're going to have a higher rate when you have that. Yeah. So that's part of it. But like the long-term story of course it's the debt story. That's where we started. Of course, the world is woken up to the fact that not only the U.S. But all the developed countries have too much debt. Yeah. They have no political machinery to solve the problem. And you're going to loan these people money for 30 years or 10 years or 20 years. And what do you want to get paid? Yeah. You want to get paid more. And fair enough. Right? So you think about risks to global markets, which we do because we're sad people like that. Yeah. Like one potential way this could all go wrong is that debt markets really do properly blow up. Yes. Another is that something goes wrong with the AI trade for example or with corporate America. But I wonder what your thoughts are on.

20:04Also last week we had a speech from Andrew Bailey who's the governor at the Bank of England. Who was saying I really think people who run banks and investment firms need to think carefully about what they would do if some AI widget managed to get inside their system and hack them. And that we're not potentially too far away from the point where that is a genuine possibility that AI's could turn hostile on financial institutions. I mean, what can you do about that? Nothing. I mean, I thought the quote of the year was actually so I don't know how many you followed the hugging face story. Yeah. So they have some toy over there at open AI working in what they think is a locked room of computers. Obviously I'm speaking metaphorically and it's the new experimental model and it breaks out into the computers of another company and starts having a screw around in there. I mean, this is a big deal. This is something they didn't, the company didn't know they were connected to the internet.

21:06The AI figured out how to find an internet connection, falsify its credentials to another corporate server, get in there and have a poke around for laughs. Yeah. And so this is a moment, right? This is the first scene of a science fiction movie, right? And once they get on top of this, which takes a week, Yes. They have a press release and a statement from open AI and Sam Altman, the head of open AI. His big comment is, oh, we're going to see a lot more of this. Yeah. And it's like, what are you talking about? You know, like, so there is a sense that the people running the AI companies, which are the most valuable companies in the corporate economy of America that I just mentioned, do not take a very responsible attitude towards their own product. Yeah. The kind of response we got from open AI was like that scene in Jurassic Park, you remember Clevver Girl. Yeah. Yeah. Yeah. It's like, yeah, when the velociraptors learn to open the door and get out.

22:11So I think, you know, I think he was quite right to warn. And the thing is, there can be a secondary kind of event where something like that happens and the value of the AI trade goes down. And so now, a lot of money in the US equity market, which is the cornerstone of all markets in the world, air starts to come out of that because people realize the AI future we're going to have is extremely different from the one we've been imagining a few months ago. And so then you can just have a good old fashioned market crash. Well, Street is kind of one trade now. Yeah. And that's dangerous. Yeah. And a really scary event could change that. No question about it in my mind. And Andrew Bailey is not the sort of guy to like shout fire in a crowded cinema. You know, he's like capped insensible. And if he's saying this is something that the global financial system needs to take seriously, then. Yes. I guess we need to take it seriously. So there's like at least four different ways that AI can take down global markets. Even people can kind of wake up to the idea that a lot of this stuff is not as monetizable as we all prove.

23:14That's a standard story. No one's going to pay, not as many people are going to pay for AI as the companies' pit are currently think. And the companies that use AI are like saying, well actually this is too expensive. We want to go into a cheaper model. They could infiltrate the Bank of England or the Federal Reserve or whatever it is. Or your bank account or mine. And somebody just shuts it down. And someone just shuts it down. The grown ups show up. And they're borrowing so much money. Yeah. That you know, borrowing quickly can often go wrong. I mean, I think of debt as a kind of financing that is very attractive, but makes risks riskier. Right. Because when you have equity financing, nobody's knocking on the door to be paid immediately. And whatever risks you have in the company when it's not indebted, they're bigger when you carry a lot of debt. And now the companies that used to be the great equity machines of all time are becoming debt machines. Yeah. And so that's a risk. But I just kind of worry that they borrowed all this money so that they can build data centers. And now let load ladies are sitting in front of the bulldozers and saying, well you can't build them here.

24:14We're not doing it. Yeah. So where does the money go? I mean, I think Francis Fukuyama, I don't know if anybody saw Frank, my friend Frank. He made a good point about the data center thing. It's not that the data centers are so horrendous, but they're a physical symbol of something much larger and more complex that we all feel. Right. And so the data center is the concrete physical manifestation of something we have much larger vague or worries about. Yeah. We don't want the box. Even if the box isn't the problem, they're sending a message. And these companies, I think, by the way, one outcome we haven't discussed is everybody makes a shit load of money. Yeah. And that's great. Yeah. That's the outcome we're looking forward to here. Everyone happy. But these companies are assuming they can pull a Travis Kaleneck, the guy who found a doober. And Travis Kaleneck was like, damn the torpedoes, damn the regulators. I don't care what the taxi drivers say. I don't care what the town say. I don't care if London makes me illegal. We're just putting ubers. And what's going to happen is eventually everybody is going to like ubers enough that it's not going to matter.

25:18We're going to win the political war by giving everybody a product. They like so much that the nervous nellies who don't like it and the taxi drivers and the city council, they're not going to matter. They suck it up. Yeah. Won't perfectly. Yeah. Home run for uber. People like taking ubers, the other stuff doesn't matter. Is that going to happen with AI? If you're an investor, you better hope so. Yeah. I haven't got any better ideas at the moment. I think we are pretty much banged out of time. So we have to do. Long and short. We always do. Long short. That part of the show, we go long. I think we love. Or short a thing we hate. Normally, I've got one ready and Rob has forgotten. But on this occasion, Rob's got one ready. And I have forgotten. So you go first. I have a pair of trade. I'll go first. I'm short the whiskey business. There was a great article in the FT about how there's too much scotch. And people are healthy now.

26:19They drink less of this stuff. Meanwhile, it had been a major source of capital. People like it invested in building more distilleries. So there's like a lock full of scotch in Scotland they didn't do with. And this happened in Kentucky in America a few years ago. It's a serious problem. It takes a long time to fix. So I'm short the business. I am long drinking whiskey. Yes. Because I really look forward to helping empty lock whiskey in Scotland. Which I feel is my patriotic duty. Yes. Someone descended from the scotch. Yeah, absolutely. Yeah. I think we're going to start doing that in about an hour. Yeah. I'm going to be a ploying and sentimental and say it's just so nice to see our listeners in real life. Because we sort of chat to each other in a dark cell. And we kind of forget sometimes that there are like real people who listen to us. And it's lovely to see you in real life. Thank you for listening. Please tell all your friends about the podcast. Listen to it wherever you get your podcast.

27:20And thank you so much for coming on. Listen to us today. Thank you. Thank you.