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Speaker 1: Welcome to Ask Fear and Greed, where we take your

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Speaker 1: questions and do our best to answer them. I'm Michael Thompson,

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Speaker 1: and good afternoon, Sean.

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Speaker 2: Aylmer, Good afternoon, Michael.

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Speaker 1: Sure, goodness me. Today's question? Wow, it has come in

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Speaker 1: from Hayley and Hailey, says Hi, Sean and Michael love

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Speaker 1: the podcast. Great start, isn't it. She then goes on

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Speaker 1: to say, I have been listening to you for some

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Speaker 1: time now. It's always a great way to start my morning.

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Speaker 1: Can you please explain what it means when you say

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Speaker 1: markets have now priced in a sixty or seventy five

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Speaker 1: percent chance of the FED cutting rates. Particularly, I want

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Speaker 1: to understand how do we know that markets have priced

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Speaker 1: in something and where does the percentage rate come from?

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Speaker 1: Is it economists that provide that data or is it

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Speaker 1: reflected in the futures market. I hear markets talk about

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Speaker 1: it all the time. This news has already been priced in,

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Speaker 1: et cetera. So just curious as to how do we

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Speaker 1: know and how do we know the extent it has

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Speaker 1: been priced in? Sean, I have never been more glad

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Speaker 1: that these questions are directed at you and not me. Okay,

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Speaker 1: I have no idea.

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Speaker 2: Yeah, I'll try on this. It's not particularly easy to understand.

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Speaker 2: So a bond's yield, it's at the very beginning. A

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Speaker 2: bond's yielded is the return an investor expects to receive

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Speaker 2: each year over the term of its maturity. So it's

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Speaker 2: over the whole period. This is what investors expect to receive.

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Speaker 2: It's like an average over the term of the bond.

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Speaker 2: Got to keep that in mind. Yields go up and down,

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Speaker 2: but the yield in any moment of time is what

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Speaker 2: investors think a bond will average between that moment of

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Speaker 2: time and when it matures. Now, we normally talk about

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Speaker 2: three year and ten year government bonds. When we talk

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Speaker 2: about markets pricing in a rate cut, which is a question,

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Speaker 2: we're actually talking about very short term bonds. And to

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Speaker 2: confuse things, a short term bond is normally called a bill,

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Speaker 2: believe it or not, just to highlight that they are

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Speaker 2: short term. But let's not confuse things too much. So

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Speaker 2: when the bond market is pricing in a fifty percent

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Speaker 2: it's easier for the numbers fifty percent chance of a

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Speaker 2: rate cut. We are talking about very short term bonds

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Speaker 2: or bills, maybe one month three months or six months.

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Speaker 2: A few things to keep in mind at this point.

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Speaker 2: Let's talk about three month bills for this example. So

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Speaker 2: we're August, so it matures in November. Whatever it is

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Speaker 2: yielding today, the sixth of August is what investors think

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Speaker 2: they'll get for it on average over the next three months.

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Speaker 2: We're also thinking in terms of the Reserve Bank cutting

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Speaker 2: or lifting interest rates in twenty five basis point increments.

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Speaker 2: So with that in mind, if the Reserve banks benchmark

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Speaker 2: rate is four point three five percent, three month bill

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Speaker 2: is returning four point two two four point two three percent,

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Speaker 2: let's say four point two two five percent, investors are

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Speaker 2: saying for the term of that three months, for the

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Speaker 2: term of that bill, they expect to get twelve point

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Speaker 2: five basis points less than the current benchmark rate four

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Speaker 2: point three five monus the four point two twenty five

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Speaker 2: So twelve point five basis points less than the benchmark

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Speaker 2: rate over the next three months.

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Speaker 1: Right, Oh, I am, I am trying so hard to

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Speaker 1: stay with you here, Sean. I'm this is this is

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Speaker 1: my absolute concentration phase, and I haven't content it's hard

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Speaker 1: since year twelve.

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Speaker 2: Right, So the efficient rate four point three five the

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Speaker 2: three month bill four point two two five difference. The

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Speaker 2: twelve point five is half of twenty five. Were talking

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Speaker 2: about the Reserve Bank moving in twenty five basis point

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Speaker 2: increments twelve point five and twenty five is half. That's

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Speaker 2: where the fifty percent chance comes into it. So what

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Speaker 2: we're saying is if the three month November bill is

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Speaker 2: returning four point two two five percent, what we're saying

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Speaker 2: is that it's priced in a fifty percent chance of

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Speaker 2: a twenty five basis point rate cut by November. Michael,

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Speaker 2: you don't look like you look with me on this.

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Speaker 1: No, no, no, I am. I think I'm with you. I've

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Speaker 1: just got my fingers crossed it. There's not a test

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Speaker 1: at the end.

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Speaker 2: The funny thing, it is actually more complicated than that

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Speaker 2: because yields involved secondary market trading and coupon rates. But

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Speaker 2: for the purpose of what we're saying, we're going to

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Speaker 2: ignore all that stuff, and there's no when we say

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Speaker 2: fifty percent chance, there's no guarantees going to happen. And

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Speaker 2: in fact, what I should be saying the market is

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Speaker 2: inferring a fifty percent chance of the Reserve Bank cutting

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Speaker 2: rates by November, because at the moment. The three month

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Speaker 2: bill rate you can buy at four point three five

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Speaker 2: percent when it's yielding less than that, it means people

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Speaker 2: have bought more of it because I think interest rates

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Speaker 2: are going to fall, and so you get the difference

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Speaker 2: between what the benchmark grade is and what it's yielding.

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Speaker 2: Put that on top of twenty five basis points, because

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Speaker 2: that's what we how we think the reserve beak moves,

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Speaker 2: and that kind of gives you your percentage chance. Ah,

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Speaker 2: this might not be the most successful ask for and

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Speaker 2: great answer.

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Speaker 1: Did you follow that one?

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Speaker 2: Hailey?

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Speaker 1: Goodness? Right now I can actually hear Haley's regret at

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Speaker 1: sending in this nation.

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Speaker 2: Look, without putting anything ten what it is, bond markets

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Speaker 2: do it right, and it's what an investor is prepared

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Speaker 2: like to buy a bond out and get in return

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Speaker 2: compared to what the benchmark grade is and the difference

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Speaker 2: that's how we calculate the percentage chance. Okay, that makes sense,

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Speaker 2: figured all the maths. It's just the benchmark rate compared

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Speaker 2: to the yield. The difference on twenty five calculates the

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Speaker 2: percentage chance.

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Speaker 1: That actually makes sense.

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Speaker 2: I should have said that up front.

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Speaker 1: So I think we enjoyed the verbal mathematics. It was

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Speaker 1: like that you are actually doing an exam, and you

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Speaker 1: know by those exams where they say you must show

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Speaker 1: your working, and you insisted on showing your every part

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Speaker 1: of your working for that just in case you got

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Speaker 1: the final answer wrong, you could still maybe get kind

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Speaker 1: of I don't know, a couple of points that's right,

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Speaker 1: way perfect. Yeah, look, I think we've done it, Hayley.

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Speaker 1: Let us know. Are you satisfied with the answer? You know,

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Speaker 1: I know enough now that if someone was to ask

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Speaker 1: me at a party, I can't imagine what kind of

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Speaker 1: party it'd be where someone would come up and ask

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Speaker 1: me this question. But I would have enough to b

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Speaker 1: s my way out of that.

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Speaker 2: No, you wouldn't. You just send them to the website.

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Speaker 2: So you got a fear and greed.

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Speaker 1: Yeah, we didn't ask for your and greed on this

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Speaker 1: a few weeks ago. Fascinating stuff. Make sure you've got

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Speaker 1: a quiet room and a pencil and ran and bear it.

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Speaker 2: I'm walking your way head down.

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Speaker 1: Goodness, met, there we go, Hailey, Thank you very much

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Speaker 1: for sending in your question.

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Speaker 2: It is an.

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Speaker 1: Absolute cracker, and I don't think I've enjoyed an answer

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Speaker 1: more so, Thank you Hailey, thank you Sean.

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Speaker 2: Thank you Hailey, thank you Michael.

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Speaker 1: And remember, if you've got something that you'd like to know,

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Speaker 1: then please send through your question on LinkedIn, Instagram, Facebook,

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Speaker 1: or do what Hailey did and send it in via

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Speaker 1: fearangreed dot com dot au. I'm Michael Thompson and this

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Speaker 1: is ask Fear and Greed