The Breakdown - A Nothingburger Speech that Moved Markets

Starting point is 00:00:00 Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the Big Picture Power Shifts remaking our world. What's going on, guys? It is Monday, August 25th. And today we are talking about everything that happened at last week's Jackson Hole meeting. Before we get into that, however, if you are enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to dive deeper into the conversation, come join us on the Breakers Discord. You can find a link in the show notes or go to Bit.L.Y.

Starting point is 00:00:37 breakdown pod. All right, friends, well, we had, as you guys know, on Friday, Jerome Powell giving his very final address from Jackson Hole. All week, markets had been trying to guess what he would do. Would he tamped down expectations of a September rate cut by pointing to rising inflation? Or would he give the all-clear given recent downward revisions to labor market data? Would this be a valedictory speech, with Powell taking the high road and waxing poetic about the importance of central bank independence? Or would the chairman use his final annual address to do something very out of character for him and take a big direct pot shot at the president. If you listen to the coverage here ahead of the speech, you'll know that I wasn't really

Starting point is 00:01:14 expecting fireworks like many pundits were anticipating. Powell's entire tenure has been characterized by his conservative nature, and it would have been very surprising for him to deliver a final flashy speech. Jackson Hole is typically used to mark turning points in monetary policy and chart a new course for the coming year. But with Powell said to be replaced in May, it wasn't clear how much he would want to stamp his imprint on future policy. Still, even with that prediction, it was surprising even to me just how bland the speech was. Powell didn't give us any flourish or key phrase. Instead, the speech was workmanlike. And frankly, Powell's persistent cough made it seem like he was struggling just to get through it. The speech was delivered in two

Starting point is 00:01:51 halves. First, Powell discussed the current macro conditions in the Fed's outlook on rate policy. Second, he delivered the results of the Fed's monetary policy framework review which occurs every five years. It was extremely dry, technical, and full of jargon. However, the speech completely bucked market sentiment, triggering a firestorm of discussion and completely shifted expectations for the balance of the year. Some even suggested it marked the end of conventional monetary policy. Far then from a nothing burger, it was an extremely consequential speech from Powell, and some of the big takeaways could shape markets for the coming years. So let's start with the first half, which was the Fed's view on economic conditions and their forward guidance.

Starting point is 00:02:28 On inflation, Powell suggested that shifting tariff, tax, and spending policies still present a lot of uncertainty. However, he has now adopted the position of the doves on the committee, stating that tariffs are likely a, quote, one-time shift in the price level. He did note that one-time does not mean all at once, and commented that tariffs could still feed into the economy and drive an inflationary spiral. Powell said that the Fed would not allow a one-time price increase to become an ongoing inflation problem. However, he seemed to fall down on the side of the argument that runaway inflation isn't currently the major risk. On the labor market side of the mandate, Powell underlined the huge downwards revision and jobs numbers from earlier this month. He noted that this slowdown didn't seem

Starting point is 00:03:05 to open up a large amount of slack in the labor market, adding, while the labor market appears to be in balance, it's a curious kind of balance that results from a market slowing in both the supply of and demand for workers. Powell continued, the unusual situation suggests that downside risks to employment are rising, and if those risks materialize, they can do so quickly in the form of sharply higher layoffs and rising unemployment. One key point was that Fed policy is only effective in smoothing economic cycles, but completely ineffective when it comes to structural changes in the economy. Powell noted that both trade and immigration policy were distorting the economic picture. However, the Fed's role isn't to correct these structural changes. It's only to smooth out the

Starting point is 00:03:42 business cycle. Concluding this section of the speech, Powell said, putting the pieces together, what are the implications for monetary policy? In the near term, risks to inflation are tilted to the upside, and risks to employment to the downside, a challenging situation. When our goals are intention like this, our framework calls for us to balance both sides of our dual mandate. Our policy rate is now 100 basis points closer to neutral than it was a year ago, and the stability of the unemployment rate and other labor market measures allows us to proceed carefully as we consider changes to our policy stance. Nonetheless, with policy in restrictive territory, the baseline outlook and the shifting balance of risks may warrant adjusting our policy

Starting point is 00:04:19 stance. That comment was enough to signal that the Fed was open to a cut in September, and frankly was a lot farther than I thought we were going to get in that direction. I would have assumed entirely that Powell was going to try to tamp down on rate cut expectations just to give himself more flexibility. That's not what happened. Analyst took the speech as extremely dovish based on that last sentence alone. Odds of a rate cut moved from 75% when Powell started talking to to 85% once he finished. And risk assets took off having one of their strongest days in several weeks. Now for some, if you were just there for the rate cuts, that was all you needed to know. You were good to go, turn it off, and move on your merry way.

Starting point is 00:04:55 However, the second half of the speech was ultimately the far more controversial, dealing with the Fed's revision of their monetary policy framework, also known as the consensus statement. The revision takes place every five years and resets the language around how the Fed interprets the mandate given to them by Congress. In the last revision in 2020, the Fed introduced the idea of average inflation targeting. At the time, rates had been at the zero lower bound for the better part of the last decade. The world had just gone through the COVID shock, and most policymakers were concerned about

Starting point is 00:05:22 the risk of another slow recovery, similar to the one coming. coming out of the GFC. With that in mind, the Fed gave guidance that they would allow inflation to run slightly above the 2% target without hiking rates in order to make up for the years where inflation ran below target. This policy seemed like it was partially responsible for the Fed's late start on hiking rates. This year's revision did away with average inflation targeting. Powell noted that in 2021, quote, the idea of an intentional moderate inflation overshoot had proved irrelevant. There was nothing intentional or moderate about the inflation that arrived a few months after we announced our 2020 changes to the consensus statement. Now the target will be static

Starting point is 00:05:56 at 2% inflation regardless of where inflation had been in previous years. The second big change was a technical change in the language aiming to clean up market guidance around the labor market. The Fed will no longer mitigate quote-unquote shortfalls in the labor market, but instead look to address deviations. Powell's point was that the word shortfalls implies that there is some known level of neutral unemployment that is being targeted when that simply isn't the case. The notion of deviations means the Fed is now looking to address situations where unemployment rises from its previous level. This was also an artifact of the post-GFC era when unemployment dropped without creating a rise in inflation. The Fed will still be open to acting preemptively if falling unemployment looks to be causing

Starting point is 00:06:33 inflation. Largely, this is just a change in the language rather than the way that monetary policy will be carried out. Powell closed by reinforcing that the 2% inflation target is still in effect. He commented, we also continue to view a longer-run inflation rate of 2% as most consistent with our dual mandate goals. We believe that our commitment to this target is a key factor helping keep longer-term inflation expectations well anchored. And that's basically the sum total of the speech, a few slightly dovish but far from certain comments that could be read as openness to cutting next month, and a very technical revision to the Fed's interpretation of their mandate, which was essentially impenetrable unless you understood the full context of Fed policy over the past two decades.

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Starting point is 00:07:49 Grayscale.com. Go to grayscale.com to explore their full suite of crypto investment products and invest in your share of the future. Interpretation of the second half of the speech also wasn't helped by Powell tripping up over his words during a crucial phrase. He said the previous policy was that, quote, following periods when inflation had been running persistently above 2%, appropriate monetary policy would likely aim to achieve inflation moderately above 2% for some time. The transcript had the correct phrasing, making it clear that under the previous framework the Fed would look too correct an undershoot of the 2% target, with a period of inflation slightly above 2%. Now, while the market interpreted this speech as very dovish, Bloomberg economist Anna Wong,

Starting point is 00:08:29 decided to fight the market and the entirety of Fintwit, stating, I think Jay Powell was not being dovish today, and this is the sort of speech that people will realize how hawkish it is with time to digest, and this kind of knee-jerk reaction, only to be reversed later, had happened before. One thing Powell did today, he gave a masterclass on how to straddle between placating political pressure, giving just enough hints of openness to cuts which can be interpreted both ways, while laying the ground for hawkish response without appearing to do so. Analyst Noelle Adjason had a cleaner version of the take, commenting, so strange that the market translates not as hawkish as we feared into dovish.

Starting point is 00:09:00 And this seems to line up with how the market reacted. Powell wasn't necessarily all that dovish, it's more that the market had become increasingly convinced he would be ultra-hawkish as the week progressed. Brent Donnelly took the pulse of his research clients on Thursday and found that 93% were expecting a neutral or hawkish speech. The market's misread of the situation seemed to cause a sharp unwind on Friday morning following the speech. We could still get a rate cut next month, Powell was far from locking it in with his speech. Instead, a cut will hinge, as it always has, on August economic data, giving the Fed the all clear. The second point of discourse that

Starting point is 00:09:31 overlapped and interfered with Anna's point came from a very loud contingent on Twitter. They declared this speech to be the most dovish thing a Fed chair has ever done to the point of abject irresponsibility. Ben Hunt of Epsilon theory wrote, this was a remarkably doveish speech because the Fed is no longer bound to actually getting to 2% inflation in this cycle. They're done. Combine this with the new renewed focus on maximum employment, which they have no idea how to calculate, and the White House pushed on the Fed board, they're going to run this hot like you can't even believe. Hunt's evidence for this claim was the removal of average inflation targeting from the consensus statement. Remarking on the new

Starting point is 00:10:02 statement, he commented, the Fed deleting the committee seeks to achieve inflation that averages 2% over time, all that remains of the 2% target is judgment that, quote, Longer-term inflation expectations well anchored at 2% is a good thing. Clear primacy for employment maximization, whatever that means. Lest you think this was a case of Trump derangement syndrome, Anthony Pompliano piled on the same point, tweeting, more than three years ago, I predicted the Fed would increase their inflation target rate. Today, they did something even crazier.

Starting point is 00:10:27 They completely removed a reference to any inflation target at all. The money printer is coming. Never one to mince words, Alex Kruger took exception to Pomp's view, responding, this is a thoroughly stupid take. The Fed removed average inflation targeting, not inflation targeting. The target remains 2%. AIT has not been a binding constraint for years, and it won't be binding for another two years, so its removal represents a cosmetic change. Indeed, during the speech, Powell actually reinforced the 2% target multiple times, and noted that the new consensus statement closely mirrors

Starting point is 00:10:55 the original statement released in 2012. Basically, there's not a lot of basis to think the Fed has abandoned their target. Now, to be as generous as possible to Ben's view, the Fed could decide that the 2% inflation target is no longer in the best interest of the U.S. economy, and remove it entirely from the consensus statement, but that change would presumably need to wait until the next policy framework review in 2030. Now, while Finchuit was busy arguing the points, the markets were off to the races.

Starting point is 00:11:18 Friday saw the S&P 500 close up 1.5%, the NASDAQ rise 1.8% and Bitcoin notch at 3.5%. Ethereum added 14% on Friday to briefly touch a new all-time high. Now, those crypto price movements reverted after some big whale selling on Sunday, but we will cover all of that in tomorrow's show. Felix Jovin, the host of Forward Guidance, made the point that Friday was a violent repricing of rates from a market that was caught badly offside. He tweeted, something that I think a lot of people misunderstand, but his key to understanding is how

Starting point is 00:11:45 the speculation in forward pricing of rate cuts does more for markets than the actual rate cut. In this era of forward guidance that we have, the forward pricing of multiple rate cuts has a real-time impact both psychologically and mechanically. This is why we saw such an outsized moved in the Russell on Friday versus the NASDAQ. Bob Elliott made the point that although Powell didn't abandon the 2% an inflation target in rhetoric or policy, the credibility is already gone. He commented, Powell without the courage to stand against political pressure. Someone needs to tell the FOMC that the quote-unquote commitment to a 2% mandate lacks any credibility when inflation has been above it for 52 months, and the Fed signals rate cuts as inflation rises and the economy is at

Starting point is 00:12:21 full employment. Others thought the speech was a complete nothing burger given the situation the Fed finds themselves in. Lin Alden commented, if you missed Powell's speech, that's okay. He basically said nothing stops this train. The frenzied reaction on C.T. seem to give Van Spencer a framework ventures a flashback to the last cycle. He commented, You never go full macro. The 22 bottom was presaged by me buying a Bloomberg terminal and trying to figure out how to book Peter Zeon for a one-on-one session to understand geopolitics. Never again. Nothing ever happens. Bloomberg terminal wasn't even used once. Total macro death. The entirety of last week was filled with doomsayers expecting a hawkish pal to pick a fight with

Starting point is 00:12:56 the president from the podium, and what we got instead was a flu-ridden Fed chair laying out some very wonkish policy concepts. So the bet on nothing ever happens seems to be far more correct than the bearish takes. One of the big things to recognize, though, is that the market has flipped from Max Doom to Max Bullish. They're basically treating it as an extremely dovish speech and expecting rate cuts in September. If that doesn't happen, or if economic data disappoints for August, we could see a big whipsaw to the downside as traders are caught offside again. Zooming out and summing up the bigger picture, TXMC trades wrote, As Powell's tenure ends, the last vestiges of the veil of central bank independence are eroding.

Starting point is 00:13:30 Debt to GDP levels press historical highs across the developed world. Weakening demographics tighten the labor market despite record low positive job growth. The necessities of sovereign survival will soon buy in the hands of the Fed, either through committee capitulation or the commandeering of their mandate by Congress. Ultimately, this was a fairly unremarkable final Jackson Hole speech for Powell. No big policy pivot. Just a simple, half-committed acknowledgement that it might be appropriate to cut rates next month. That's going to do it for today's episode, guys. Appreciate you listening, as always. Until next time, be safe and take care of each other. Peace.

The Breakdown - A Nothingburger Speech that Moved Markets

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