Standard Chartered Financial Markets Interview Questions

In many of my posts over the past year there’s been a consistent theme of the market getting ahead of itself on rate cuts and then – when inflation remains sticker than expected or growth remains more resilient than anticipated – those cuts getting priced back out.

However, this time really is different: never say never, but barring an extraordinary beat on payrolls tomorrow we’ll have our first rate cut of this cycle at the next FOMC meeting on September 18^th. In fact, the real debate at the moment is whether or not payrolls will be soft enough to warrant a 50bps move (while no one can know for sure, if payroll growth is 100k or less then 50bps is on the table and, for what it’s worth, right now the market is pricing in around a 40% chance of there being a 50bps move).

What’s informed this confidence that a move will occur – beyond the obvious fact that FOMC members have not so subtly hinted at the fact they’re now ready to cut – is the fact that payrolls have come in softer than expected over the last few months; wage inflation has continued its downward trajectory, thereby negating concern over wage inflation feeding back into overall inflation; and both CPI and PCE have fluttered toward the Fed’s target in a somewhat linear fashion.

This has all had the effect, as evidenced by Powell’s comments at Jackson Hole, of shifting the balance of risks: from concern over inflation and no concern over the labor market, to some residual concern over inflation and newfound concern over deterioration in the labor market.

For the past year I’ve talked a lot about the soft landing narrative and have often referenced how Jan Hatzius of Goldman deserves significant credit for taking the outlier position that a soft landing could be achieved because as the number of job openings declined (from their eye-watering levels post-pandemic), that’d put downward pressure on wage inflation, and that in turn would put downward pressure on some aspects of overall inflation and, most importantly, provide time for the transient aspects of inflation (i.e., inflation that arose from supply chain issues) to dissipate.

It's difficult to describe how much of an outlier position this was in late-2022, but it’s one that has borne out: we’ve had JOLTS compress in, wage inflation moderate to levels consistent with overall inflation within the 2-3% range, and (of course) overall inflation now down in the 2-3% range.

But, with all that said, the issue with a soft landing as a metaphor is that it denotes a plane softly landing on the tarmac and (presumably) coming to a halt (stabilized inflation around target and growth around potential). So, to stretch the soft landing metaphor further, we could very well be at the stage where the wheels of the plane have touched the tarmac, and done so without tossing anyone’s drink in the air, but it remains to be seen whether or not we’ll blow a tire as we come to a halt.

Because while GDP growth has continued to remain robust – and the Atlanta Fed’s GDPNow is still humming along at a nice clip – we’ve had the unemployment rate tick up thus arguably triggering the Sahm rule, and right now the market is pricing in a rate cutting cycle that is more analogous to what you’d see when trying to grapple with significant economic weakness (i.e., a modest recession) than a goldilocks economic environment (as the Fed, through its dots, believes will eventuate).

So, once again, we need to ask ourselves if the market – now that it's finally right about a rate cut happening – is once again getting ahead of itself on the magnitude of cuts that are to come, or if market participants will finally be vindicated in pricing in such an aggressive cut cycle...

Standard Chartered Financial Markets Interview Questions

As has become tradition, in this post I’ll discuss some market-based questions and the themes that are most impacting markets. Right now, all markets are still being driven heavily by the projected path of rates – although we’ve had a few interesting sideshows such as the Yen carry trade throwing markets into a very brief and quickly reversed tizzy a few weeks ago, and some significant market vol to start off September…

Also, NVDA had the largest loss, in market cap terms, of any stock in history on September 3^rd and is now in bear territory having fallen over 20% from its June high – but it’s not too surprising that when a stock explodes higher to become one of the most valuable in the world that it can have violent sporadic reversals that set some records.

• If you had to break down future Fed policy into two or three different pathways, what would those pathways be?
• How could the upcoming election change the Fed’s rate cut calculus?
• What’s an argument that inflation may prove more persistent than market participants currently think?

If you had to break down future Fed policy into two or three different pathways, what would those pathways be?

As previously mentioned, the Fed’s calculus has shifted, and now concerns over the deterioration in the labor market are of paramount concern. Therefore, the next few jobs reports will be critical to informing the level of rate cuts over the next three to four meetings.

Of course, an upward surprise to CPI or PCE in the next few months would create a more difficult balancing act for the Fed. However, even if there is a modest uptick in CPI and PCE it’d still be within the orbit of the Fed’s target range and as such would likely be treated as an aberration from the longer-term trend we’ve observed of inflation coming down.

Further, if there’s labor market weakness against a backdrop of higher than anticipated inflation, the Fed would view the labor market weakness as putting a capped ceiling on how much higher inflation could creep up (since the Fed doesn’t believe stagflation is a realistic concern, primarily because wage inflation has become pretty subdued, they’d be willing to look through a few high MoM CPI or PCE prints).

In the end, there are probably three broad paths for rates moving forward: a “true” soft landing pathway with fewer rate cuts than are priced in right now, a “questionable” soft landing pathway with regular rate cuts pretty much in line with current market pricing, and a more “doubtful” soft landing pathway that would feature even more aggressive rate cuts than are priced in right now.

For scenario one, in the next few months we’d begin to receive data that looks more like a true soft landing where growth remains robust and inflation appears to stabilize around target (in other words, data that’d make concerns about a recession, which have bubbled to the surface in recent months, abate). So, for example, if we end up with payrolls tomorrow of 200k or more than this would be the scenario that market participants would coalesce around (at least until future data contradicts this jobs report).

In such a scenario, as I mentioned above, the market would almost certainly have to take some of the rate cuts priced right now off the table since there’d be no real justification for aggressive cuts in the face of near full employment and modest inflation – rather, the argument would be (although it’s debatable) that the Fed should preemptively bring down real rates a bit closer to neutral, but do so gradually enough that it doesn’t run the risk of inflation reigniting or the labor market tightening back up too much. In other words, do 25bps in September since it’s priced in and then maybe do one more 25bps cut in November or December.

For scenario two, we’d begin to receive data, like we have over the last few months, that raises more questions than answers: inflation that is static or perhaps to the upside, and/or payrolls that come in below expectations but not enough to raise the unemployment rate by more than a tenth or two.

In the context of upcoming payrolls, BofA thinks that if we have a print of 100-150k then we’d see the Fed keep to a 25bps cut at their next meeting but signal that in each subsequent meeting they’d move 25bps too and perhaps would look to do around 100bps of cuts next year (keep in mind, for the remainder of this year the market is pricing in 100bps of cuts right now).

The reason I’ve called this scenario a “questionable” soft landing is that another one or two soft payroll reports wouldn’t signal that a recession has arrived, or that one is around the corner, but it would raise the probability of a recession. In other words, such data would raise more questions than answers, and would probably lead to the market pricing in even more rate cuts (there’d also probably be a bit of risk-off sentiment in equities too as the benefit of incremental rate cuts, against a backdrop of anticipated much weaker economic growth, should on balance be negative for equities since right now equities are being buoyed by pretty generous EPS growth projections).

For scenario three, we’d begin to receive data the casts doubt on the soft landing narrative altogether: payrolls below 100k and a rise in the unemployment rate. With wage inflation already quite subdued (in the US, less so in Canada, the UK, and EU despite their weaker economic backdrops) this would provide the Fed with a green light to begin an aggressive rate cut cycle (this would lead to a lot of premature market commentary about how the Fed is behind the curve, has precipitated a recession through keeping rates too restrictive, etc.).

But even one or two sluggish payroll reports wouldn’t necessarily have us see some truly aggressive rate cuts. The Fed will still remain cautious, as they’ve been for the better part of a year. Instead, we’d probably see 50bps of cuts in September and November and, if the negative economic data persists, then we’d see more aggressive maneuvers begin (whether that’s 50bps again in December and a signal of much more cuts through 2025, or even some cuts in-between meetings to bring rates down to neutral even quicker).

How could the upcoming election change the Fed’s rate cut calculus?

I’ve had an email or two over the last few months asking if it’s appropriate to talk about election issues in the context of an interview. In my view, it’s perfectly fine to talk about election issues in an interview but – and this is critical – it should be dispassionate, professional, and your interviewer should not be able to tell your political leanings from your answer.

In other words, there shouldn’t be value statements embedded in your answers (i.e., “Trump will institute more tariffs, which is a dumb idea” or “Harris has floated the idea of a tax on unrealized capital gains, which is a dumb idea”). Instead, there should be no subjective commentary sprinkled into your answers (even if you think that your interviewer would like to hear some subjective commentary that you think would align with their political priors).

So, to answer this question, we know that three things that could change the Fed’s disposition toward cutting rates would be if the economy began to exhibit strong growth, the labor market retightened, and/or inflation began to rekindle.

Here’s a long overview from Goldman of each candidate’s positions (insofar as they’ve been articulated…).

Given this, from what we know about each of the candidate’s views right now, it appears that the Harris administration would, on balance, offer a continuation of the Biden administration’s policies (except there’ll be a few more tax hikes and a bit more spending).

Whereas President Trump has proposed policies, in particular around tariffs, that if enacted we know will be somewhat additive at time zero to inflation. To this end, Goldman anticipates that for every 1.0% increase in the effective tariff rate that core PCE will rise by 0.01% and, based on the level of tariffs that GS thinks are likely to be enacted, this could feed through to a one time rise in core PCE of 0.3-0.4% (although there should be huge error bars around all of these numbers).

At the same time, immigration has been a core reason behind the labor market’s stubborn resilience over the last few years, and if the level of immigration is significantly curtailed (again, there’s no need to make a value judgement over if it should be or not) then that could tighten the labor market, spur wage inflation, and be somewhat inflationary as well (although the feedback mechanism here is iffier, and one could argue immigration declines would lower growth and thus warrant rates to be less restrictive – even if wage inflation ticks up a bit).

However, on the other hand, we’ve come through a period in which we’ve seen the federal government run relatively large deficits (that have harmed, to an arguable degree, the efficaciousness of monetary policy) and per Goldman’s calculation under the Harris administration we’d see more stimulative fiscal policy and this, all else equal, would warrant less rate cuts.

But, as the picture above illustrates, when it comes to all of these policies – whether around tariffs, immigration, or fiscal policy – their impact wouldn’t be seen right away. In fact, their impact may not even be felt through most of 2025 due to the time it takes to both enact and implement policies of any kind.

The Fed doesn’t have the luxury of prognosticating on what the impact of certain policies will be in the future and to change their outlook based on it – instead, they need to act in the here and now and if certain policies (whether they come from a Trump or Harris administration) lead to inflationary pressure in late-2025 or 2026 then the Fed will respond at that time. But regardless of who’s elected, it probably won’t change the rate pathway in a meaningful way through Q4’24-Q3’25.

What’s an argument that inflation may prove more persistent than market participants currently think?

While there has been much celebration over the “defeat” of inflation in recent months, Deutsche Bank came out a few days ago with a note to remind everyone that inflation is still a touch above target across most of the developed world and there are at least a few non-dismissible reasons to think that it could nudge higher in the near future (maybe not enough for central banks to stall or reverse their cut cycles, but enough to perhaps slow the pace of their cut cycles…).

The most convincing piece of evidence that DB highlights is something that I’ve brought up several times over the last year: that the fall in inflation we’ve seen has been driven primarily by the disinflation that we’ve seen in some inflation components (i.e., some goods), and there are still some components (i.e., some services) where inflation is running well above target. And it’s only when the disinflation in some components, when combined with the well-above-target inflation is other components, is net out that we arrive at the slightly-above-target inflation that we see right now.

But this isn’t a sustainable mix – we won’t have, and shouldn’t want to have, prolonged goods deflation that allows us to stay around target inflation overall. We should want, as we saw prior to the pandemic, both goods and services inflation roughly around target in aggregate with a few components of each sporadically being higher or lower than target.

As DB highlights in their note, if we have what they’ve called “flexible” components (primarily goods) rebound to a more normalized level – as we should want and expect over a long enough time horizon – and have what they’ve called “stickier” components remain stable around 5%, as they have been for the past year with a very modest downward slope, then we’re looking at a normalized (durable) inflation level well above target (in the 3% range, plus or minus 50bps).

The second argument that DB rolls out – there are a few additional ones, but I find them less persuasive so won’t cover them here – is that geopolitical shocks could lead to temporary supply chain issues and/or commodity price spikes that keep inflation elevated above target.

This is a fair enough argument, and we have seen a rolling series of geopolitical issues over the past few years. But, at the same time, these have been temporary shocks and the commodity supercycle thesis that Goldman’s old head of commodities research, Currie, came up with hasn't quite panned out as almost every commodity, no matter the disruptive event that has occurred, has settled into a pretty subdued range after a few weeks or months. In other words, even though we’ve faced a series of distinct geopolitical “shocks” over the last few years, this hasn’t established a new, higher floor under commodities in aggregate and hasn’t led to a material change in inflation (at least one that can’t be looked through by central banks as being transient in nature).

In fact, GS now sees the balance of risks to the downside for oil, and is forecasting pretty modest returns across almost all commodities in 2024-25…

Conclusion

As we take the first step into this rate cut cycle in a few weeks, the Fed will become even more data dependent than normal. It might be the case that data will all start to flow in the same direction, and therefore make the Fed’s decisions at meetings to come straightforward.

However, it’s much more likely that we’ll get somewhat contradictory data in the coming months that forces the Fed to take action based on their projections of how both employment and inflation will evolve over the short term. For example, think about the data we’ve received on the eve of the August jobs report: we have the Beige Book flashing recession signals, but Atlanta’s GDPNow forecast still at levels consistent with a strong economy; initial claims coming in below expectations and at levels pretty consistent with a strong labor market, but the ADP employment report being the weakest since 2021 and 50k below expectations; and we have inflation trending down, but wage inflation in ADP’s employment report at 4.9% which is a bit above levels consistent with inflation being at target.

Contradictions abound, and this has led to division over what the future will look like. With GS still confident that a “true” soft landing will occur but some others growing queasier – for example, here’s what Citi’s Hollenhorst had to say after the recent data dump we’ve received, “Falling job openings, a subdued hiring rate, soft auto sales and activity flat or contracting in nine out of twelve regions according to the Fed’s Beige Book all make the case that the US economy is more likely headed for a recession than a soft landing.”