The Breakdown - As the Market Slinks Down, It's Time to Touch Grass

Starting point is 00:00:00 What's clear is that this is the setup for the next few months at least. What's less clear is how the catalyst over the next few months will change the outlook going into the fall. But what to do in this situation? Well, as crypto-Twitter loves to say, and this is actually good advice, this might be the right time to go outside and touch grass. 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. The breakdown is sponsored by nexo.io, near NFTX, and produced and distributed by CoinDesk. What's going on, guys?

Starting point is 00:00:39 It is Thursday, May 26th, and today we're talking macro. Before we get into that, one quick housekeeping note. There are two ways to listen to the Breakdown podcast. You can find us on the CoinDesk Podcast Network feed, which features the breakdown and other great shows and comes out in the afternoon. or you can listen on the breakdown-only feed, which comes out a few hours later in the evening. Whichever way you listen, if you're enjoying the show, I would so appreciate a rating or a review. It makes a big difference for helping new people discover the podcast.

Starting point is 00:01:12 Lastly, a disclosure as always. In addition to them being a sponsor of the show, I also work with FTX. So we have had a number of crypto-related kind of grab-bag shows, keeping up with all the news in the industry. And today, we are going to check in on the macro to get a sense of which way. the winds are blowing. We're going to start with the Fed minutes. So when the FOMC meetings happen, the first chance the market has to hear about new explicit changes or forward guidance comes from the summary of the meeting and then the press conference that happens after. About a month

Starting point is 00:01:45 later, we get the actual minutes from the closed door meeting. Sometimes these don't matter much and they just reinforce what we already knew. Other times, these can be super impactful. After December's FOMC meeting, we got confirmation, as the market largely expected, that we were going to move into a regime of rate hikes going into 2022. However, when the meeting notes themselves came out in January, we discovered that the Fed was talking about not just rate increases, but a shift to quantitative tightening, i.e. balance sheet normalization and balance sheet reduction. Basically, no market participants at that time thought that the Fed was actually going to reduce the size of the balance sheet within just a couple of months of starting rate hikes, but that seemed to be what they were indicating.

Starting point is 00:02:33 That paradigm shift of the Fed moving from an era of easing to an era of tightening really kicked off the gloom in markets that has been with us all year. Yesterday's FOMC meeting minutes were not that. Instead, they were largely a confirmation of what we knew. And if there was one key theme, it seemed to be the lack of disagreement among members around what happens next. So what will happen next? The meeting minutes highlighted agreement between Fed officials that 50 basis point hikes would, quote, likely be appropriate at the next two FOMC meetings, which happened in June and July. Policymakers were unanimous in the assessment of the U.S. economy as very strong, and the labor markets is very tight.

Starting point is 00:03:16 Ross Mayfield, an investment strategy analyst at Bard Capital, said the uniformity of opinion is a good thing. There's a lack of uncertainty of what needs to be done in the near term. By the time the Fed gets to September, they will have plenty of. economic data to make their move from there, so they continue to maintain optionality." End quote. Indeed, there's something of a consensus forming around the idea that these next two hikes in June and July are baked in, and the real decision point is going to come in September. When it comes to September, not everyone is yet on exactly the same page. In comments made last week, St. Louis Fed President James Bullard said that his base case for the next 18 months is that

Starting point is 00:03:53 the labor market will remain tight and U.S. consumption will remain elevated. On that basis, he expressed the desire to get the target Fed funds rate to 3.5% by the end of the year, which would necessitate 50 basis point hikes not just in June and July, but at every meeting for the rest of the year. On the other hand, Atlanta Fed President Rafael Bostick said on Monday that he'd like to pause further rate hikes at the Fed September meeting to allow time to assess the impact of tighter policy on the economy and inflation. Bostick said that he's still in favor of 50 basis point hikes at the next two meetings, but foresees that it might be necessary to reduce the rate of hiking after that.

Starting point is 00:04:28 So basically where we are, the point here is that there's broad agreement demonstrated in both Fed minutes and statements from Fed presidents that we'll see an additional 1% hike in interest rates over the summer, and then the September FOMC meeting will be the first major decision point and will hinge on a variety of different data, including labor market tightness, strength of the U.S. consumer economy, and of course, and primarily inflation data, which they see is continuing to run at far too high a level. Now, there are a whole range of things that could end the Fed tightening cycle prematurely. Disorderly markets, especially the Treasury market, increased unemployment, which gives the Fed

Starting point is 00:05:06 less freedom to tighten with no consequences to the other side of their mandate for full employment, and of course other major problems in data, such as signs of a recession being confirmed. However, the overwhelming message we're getting from the Fed is that we're not there yet. Nick Timoros, the chief economics correspondent at the Wall Street Journal, said, Fed policy appears to be on cruise control through July. That is setting up a debate over whether the data will call for the pace of rate rises to change in September. Lots to digest between now and then. Lynn Alden says the Fed is going to tighten monetary policy until something breaks, something like

Starting point is 00:05:39 Treasury Market liquidity or credit market liquidity. Of course, as all of this has been happening, risk markets have been rough. There is a lot of speculation in financial market commentary around the idea of the Fed put. In other words, the point at which the pain of a downturn in markets poses a risk to the broader economy, forcing the Fed to step in and rescue markets by loosening monetary policy or performing emergency actions. So far on the year, the S&P 500 is down more than 15% while the NASDAQ is down more than 25%. In Davos on Monday, Citigroup CEO Jane Frazier noted that the sell-off in the U.S. markets had been, quote, remarkably orderly by Wall Street standards. Quote, they have not sprinted to the door the way they

Starting point is 00:06:21 have with the world financial crisis when that crash happened and where we were in 2020. We have seen a fairly systematic takedown and change in asset allocation. She went on to characterize the downturn as a necessary correction instead of a crash and said, quote, this hasn't been the catastrophe it could have been. We're also seeing a bit of the same sentiment in bond markets. Matt Ness, who's the global head of fixed income at State Street, said credit really hasn't cracked. The sell-off has been relatively orderly to date, which is a sign of health.

Starting point is 00:06:49 When people look at tech stocks and how far down they are, the interpretation right now is more like a rational and deliberate repricing and a real push to test the endgame for some of these tech business models. UBS CEO Ralph Hammers said clearly there is a question of what should the exact market value be of some of these models. So you're seeing something come into clear view here, and this is pretty well summed up by Asset Reset on Twitter, by not capitulating and keeping the selling orderly, market participants are indirectly telling the Fed, it is all okay. They're still playing with house money. No harm done, as we're still above pre-pandemic highs. Keyboard Monkey writes, capitulation isn't a downside number or percentage. It's a day or period when the market is

Starting point is 00:07:34 completely disorderly with indiscriminate selling. A day with no liquidity and insane price gaps. All we've experienced is orderly selling. This isn't capitulation. Another way to put it comes from Roy Blackstone, who wrote, knife to zero. It's a slow, boring, endless grind where prices fall a little more every day. It's death by a thousand cuts and by the time you look back, you realize it's all gone. It takes years. You better believe in bare markets. You're in one. Looking for ways to step up your crypto game? Then go with Nexo. For starters, you get free crypto for each purchase or swap. How about earning guaranteed yields? Up to 17% paid out daily. Ideal for you hardcore hodlers.

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Starting point is 00:09:47 some of the traditional signs really aren't there. Vixoyan writes, this would be the first time in history of Wall Street if market bottoms without fear. one more time drop to do what? It's already low with 20% down and everything is so orderly and nice. VIX is nicely consolidating. We could sit here for another six months with SPX at 3,500. There is of course another side of this, though, which is part of what markets are hanging on the Fed's every word about, is at what point the Fed will have to turn back on really accommodative monetary policy. In other

Starting point is 00:10:18 words, put money back into the system instead of the other way around. Stephen Poonwasi from Business Insider says we might be in the greatest bubble in history. Central banks broke markets so much that people want a downturn thinking it means higher asset prices. Government and central banks created so much moral hazard, mom and pop don't want a strong economy, they want a bailout. Now, I'm not sure that mom and pop are exactly the people who want to bailout, but certainly Wall Street, who has grown so used to the accommodative conditions do. And speaking of mom and pop, it's important to remember that not everything in the economy is the stock market. So how are other sectors doing? Well, let's start by looking at housing. Bloomberg this week published a piece called pandemic housing boom hits a wall

Starting point is 00:10:59 with U.S. buyers priced out. The key quote, buyers who once had to make on-the-spot offers now have time to shop and even negotiate, and some sellers are doing something unthinkable just months ago, slashing prices, end quote. U.S. housing is showing the first signs of cooling off. April sales figures for new homes decreased by 16.6% to their lowest level since April 2020. Indeed, U.S. pending home sales have dropped for a sixth month, the worst skid in the market since 2018. Overall, this is the largest drop in new home sales in almost nine years. So what are the factors going into this? Well, there are still high cost present with labor materials and fittings, all of which are well above historic normal market prices. Up until basically right now,

Starting point is 00:11:42 mortgage prices have been increasing over the past four months at the fastest pace experience since 1981. And while some sellers have started to mark down their homes for sale, there is a real psychological barrier there, right? There's a general reluctance to sell at lower prices than were available only months ago. So we have this weird, liminal state where buyers are unwilling to buy at the asking prices, but sellers are unwilling to discount to meet buyers where they are. One number that is extremely promising in the long run is that the additional supply coming onto the market has recently shown a large jump, with newly built inventory up to nine months supply from the less than six months supply that was available at the start of the year.

Starting point is 00:12:20 This is the largest supply of new homes that has been available since 2008. Now, this is a little bit turbulent. Just this morning, Bloomberg reported that mortgage rates fell to 5.1%, their biggest drop since April 2020. On the one hand, that's good. Perspective homebuyers are already dealing with inflation, with record high prices. Mortgage rates going up was pricing some of them out of the market entirely, so that leveling off or even going down could be really good. The flip side is that it reflects some troubling realities.

Starting point is 00:12:48 The mortgage market has been drying up. Lenders are struggling to find enough new loans to write. Refinancing has dropped off completely, 75% lower than it was last year. New loan applications are down 16% from last year. An overall mortgage demand is now close to the lows from spring of 2020. We're even starting to see some layoffs among mortgage lenders and some are starting to toy with the idea of moving into writing more subprime loans in order to remain operating. Infosec worker true demons sum this up. The market is about to get a heavy dose of reality. Starting with the fact that housing supply has just skyrocketed in a single month from less than six to nine months supply. Buyers are giving up, sellers are being turned down, home builders are canceling contracts, foreclosures are

Starting point is 00:13:32 up. So that's the story in housing. But what about other key real world sectors like retail? Last week, Walmart and Target announced their financial results for the first quarter of this year, and one really notable part of the story was that both showed large inventory accumulation, and the need to mark down prices. Historically, large inventory buildups are a good leading indicator of a recession. They signal that consumer demand is weakening, but in this case, there are some additional factors. Supply chain disruptions at the end of last year meant that multiple ordering was common. Some amount of this additional inventory represents those additional orders showing up. In fact, this may not be an indicator of an incoming recession,

Starting point is 00:14:11 but instead, reflective of the fact that the U.S. consumer goods economy is experiencing the tail end of something called the bull whip effect. The bull whip effect reflects the idea that small changes in consumer demand can have larger ripple effects down the supply chain. This effect was super noticeable during the initial COVID lockdowns as demand shifted with items like toilet paper and supermarket food being in shortage at the stores, but not necessarily actually in short supply within the economy. Similar sorts of issues have been experienced throughout the supply chain over the past two years as retailers have struggled to maintain stock of the correct categories of items to keep up with demand. These changes in demand patterns quickly deplete supply at retailers who then order more

Starting point is 00:14:48 than usual with wholesalers, who then demand more to be produced at manufacturers, and by the time the entire supply chain has adjusted to the initial extra demand for consumers, that demand may have disappeared, leading to additional supply throughout the entire supply chain with no demand at the end of it. Unfortunately, while this may be a bullwhip effect rather than the collapse of the U.S. consumer, the effect on inflation and recessionary impulse may ultimately be the same. i.e. tapered down production at manufacturers leading to layoffs, and discounting at retailers sending a disinflationary impulse through the consumer goods economy. Isabella Kaminsky of The Blind Spot says the inventory situation is super important to keep an eye on now.

Starting point is 00:15:27 Stock overhangs on weakening demand could prompt a violent snapback in inflation via discounting, and then team transitory might still save face. But if you consider that inflation is just a form of rationing, what the current situation might lead to is a reduction of choice and variety of product. only the most efficient suppliers and manufacturers will survive. So let's sum up the story. The Fed is locked into a course of action for at least the summer. Markets are proceeding downward in an orderly fashion. The housing market is really cooling down,

Starting point is 00:15:55 and retail inventory is building up. What's clear is that this is the setup for the next few months at least. What's less clear is how the catalyst over the next few months will change the outlook going into the fall. But what to do in this situation? Well, as crypto-Twitter loves to say, and this is actually good advice, this might be the right time to go outside and touch grass. For now, I want to say thanks again to my sponsors, nexo.io, NIR and FTX, and thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace. Hey, breakdown listeners, come join CoinDesks Consensus 2020, the festival for the decentralized world this June 9th through the 12th in Austin, Tech.

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The Breakdown - As the Market Slinks Down, It's Time to Touch Grass

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