The Breakdown - Fed Cuts But Says That's It

Episode Date: December 20, 2024

The market had its worse reaction to a Fed meeting in the last few years as the FOMC cut rates as anticipated, but revised future projections to reflect more uncertainty on cuts in 2025. NLW covers the news and the reaction. Enjoying this content? SUBSCRIBE to the Podcast: https://pod.link/1438693620 Watch on YouTube: https://www.youtube.com/nathanielwhittemorecrypto Subscribe to the newsletter: https://breakdown.beehiiv.com/ Join the discussion: https://discord.gg/VrKRrfKCz8 Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW

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 Thursday, December 19th, and today we are talking about the latest Fed 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.ly slash breakdown pod. All right, friends, how's it going? First of all, apologies for missing the show yesterday.

I was completely taken out by illness. You can probably still hear it. I think I'm on the recovery path, but obviously we can't miss more than one day. And given that it was Fed meeting day, it seemed like a good time to come back. So the TLDR is that the Federal Reserve cut rates at yesterday's FOMC meeting, but signaled the reluctance to continue the cutting cycle into the new year. The quarterly statement of economic projections or dot plot now shows only two rate cuts next year, down from four in September's SEP, one Fed official marked down zero rate cuts in 2025,

and three officials expected only a single cut. The message was widespread uncertainty that further rate cuts are justified by current economic conditions. Fed Chair Jerome Powell said, with today's action, we have lowered our policy rate by a full percentage point from its peak, and our policy stance is now significantly less restrictive. We can therefore be more cautious as we consider further adjustments to our policy rate. Rates are still viewed as restrictive, but there isn't any urgency then to loosen policy any further. Walking through the economic projections, Powell noted that the labor market has now cooled

to below levels from 2019. Still, he believes the slowdown in employment is slow and stable. Powell noted that the Fed does not feel they need to see further labor market weakness to bring down inflation. Inflation is believed to still be on a course to the 2% target but on a much longer time frame. The SEC showed Fed officials believe that unemployment will tick up slightly next year, and they also believe that inflation will slightly increase to 2.5% in 2026. The latest round of projections shifted achievement of the 2% goal out until the end of 2020. pushing it back a full year from September forecasts. Essentially, all economic metrics are tracking sideways and the Fed is looking to respond to incoming data rather than get ahead of it.

With all that established, Powell was asked why the Fed would cut at all. He said, Today was a closer call, but we decided it was the right call. The decision had a rare dissent, with Cleveland Fed President Beth Hammock voting to hold rate steady. Language was changed in the meeting notes to state that the Fed would consider the extent and timing of further policy adjustments. Historically, this language has always preceded a long rate pause. Looking out into next year, Powell said, We coupled this decision today with the extent and timing language in the post-meeting statement that signals that we are at or near a point at which it will be appropriate to slow the pace of further adjustments.

The slower pace of cuts for next year really reflects both the higher inflation readings we've had this year and the expectation inflation will be higher. Nonetheless, we see ourselves as still on track to continue to cut. I think the actual cuts that we make next year will not be because of anything we wrote down today. We're going to react to data. That's just a general sense of what the committee thinks is likely to be appropriate. This is an important statement to me because it says something which is always true but not regularly acknowledged, which is that these projections are based on people's assumptions about what data they're going to get in the future.

It's not a sort of a priori we need two or three more cuts. It is instead a bet that based on what they expect the underlying data to be during those periods of time, two or three cuts will be appropriate. The change of administration was discussed with Powell questioned on whether the Fed is holding tight in anticipation of inflationary policy from Trump. quote, some people did take a very preliminary step and started to incorporate highly conditional estimates of economic effects of policies into their forecast at this meeting and said so in the meeting. Other officials didn't consider these factors while some stayed silent on the topic. It seemed like the biggest impact of the change in administration was Fed officials penciling in more uncertainty about the path of inflation. Upside risk to inflation significantly increased in the forecast compared to three months ago. Regarding tariffs, Powell insisted that the

outcome isn't known. In 2018, the Fed modeled the outcome of increased tariffs. The analysis has showed a range of pathways, with some having no impact on inflation whatsoever. Powell said, We just don't know very much at all about the actual policies, so it's very premature to try to make any kind of conclusion. Although Powell suggested that no one on the committee has firm views on the impact of a Trump administration, he noted, it's common sense thinking that when the path is uncertain, you go a little slower. It's not unlike driving on a foggy night. Personally, I definitely think that this was a huge factor in this meeting. I think that Powell was reflecting the way that they're thinking about it accurately, that it's less being sure that policies are

going to be inflationary, and more just having a much less clear sense of what's going to happen at all. Overall, the Fed believes that policy is in a good place to respond to whatever comes next. The Fed funds rate has now caught up to the two-year Treasury rate, implying that the Fed is no longer behind the curve. When it was suggested that the Fed is out of the recalibration phase, Powell quipped, we're not renaming the phase yet, but I would say that we are in a new phase in the process. Digging deeper on inflation, Powell was asked how much attention the Fed is playing to idiosyncratic

problems. Recent high prints in inflation have revealed isolated issues such as the price of cars jumping following the hurricanes and the price of egg surging due to avian flu. Powell said, the story is still just that we're unwinding from these large shocks the economy got in 2021 and 2022. For example, housing services and now also in insurance where costs went up, and those are now being reflected later. It's real inflation, but it doesn't pretend persistently high inflation. We and most other forecasters still feel that we're on track to get down to 2%. It might take another year or two from here, but I'm confident that that's the path

that we're on, and our policy will do everything it can to assure that that's the case. At this point, one would be forgiven for thinking that Fed policy is out of tools to achieve the last mile on inflation. Powell noted that most of the stickiness that remains is in a category called non-market services. That is, prices that are imputed in the data rather than measured in the market. He gave the example of financial services, which are calculated using a formula that includes asset prices. Essentially, it seems that the Fed won't react to small increases in inflation unless they believe that interest rates will make a meaningful difference. They're not looking to change policy just to be seen to be doing something.

Powell also mentioned the slowdown in the housing sector as a clear example of an interest rate-sensitive area of the economy. Mortgage rates are back up to 7%, and housing stock is steadily rising. He said, So we think our policy is working, it's transmitting, and it's having the effects on our goal variables that we would want. Inflation concerns really were the major focus of the press conference. Powell noted that inflation expectations remain anchored and that there aren't any serious

signs of another surge. However, he said, what the public is feeling and they're right about is that the price level went up because of the past inflation. It's going to take some time for real wages to recover over a period of years in which your compensation is growing meaningfully faster than inflation. That's exactly the kind of economy we have now and we just want to hold on to it. As it seems the Fed won't take action to drive inflation down further, Powell was questioned whether the Fed is settling for 2.5% inflation.

He said, no, we're not going to settle for that. I think we certainly have every intention and expectation that we'll get inflation back sustainably to 2%. I'm confident we will achieve that. It has taken longer, but we've made a great deal of progress and we'll continue to do so. We'll get back to 2% inflation. That's what we owe the public and we're committed to achieving it. Powell then asked whether he could rule out a rate hike next year to which he responded, you don't rule things completely in or out in this world. That doesn't appear to be a likely outcome. We're at 4.3%. That's meaningfully restrictive and a well-calibrated rate for us to continue to make progress on inflation while keeping a strong labor market.

The other side of projected Fed inaction was the steady level of unemployment. At 4.2%, the unemployment rate is now back to the level that triggered concern and a 50-bases point rate cut in September. Powell explained that there's a huge difference between unemployment rapidly trending up and remaining flat as it is now. He noted some concern with the lack of open positions, pointing out the job creation is now below the rate required to keep unemployment constant. However, the forecast for a slow rise of unemployment is no cause for concern as long as things don't accelerate. Another big theme of the press conference was the relative strength of the U.S. When asked whether the U.S. has avoided the heavily forecast recession, he said,

I think it's pretty clear we've avoided a recession. I think growth this year has been solid. It really has. The U.S. economy has just been remarkable. When we attend these international meetings, this has been the story, how well the U.S. is doing. If you look around the world, there's just a lot of slow growth and continuous struggles with inflation. Us, bitcoiners did get a little shout out. The Bitcoin's Strategic Reserve was brought up, showing how much the idea has entered the ether, with Powell being asked for his opinion on the policy. Dodging the question, he simply stated, we're not allowed to own Bitcoin. The Federal Reserve Act says what we can own and we're not looking for a law change.

That's the kind of thing for Congress to consider, but we're not looking for a law change at the Fed. As a brief note, no one is suggesting the Fed should manage the Bitcoin Reserve. That would be done through the Treasury just like the Gold Reserve. Overall, the takeaway, very clearly and loudly, was that the Fed is done. I'll claim that policy was in a good position to react to further changes. However, at this moment, the FOMC does not see any particular reason to move. While this might then seem like a fairly sedate Fed meeting, that actually couldn't

further from the truth. The Fed took two rate cuts off the table for next year, shortening the cutting cycle significantly. Markets had expected a cut at this December meeting, however, they were also pricing in fairly good odds of a further cut in January, and another sometime later in the first half of next year. Those odds have now collapsed. There is a high level of uncertainty that will see any rate cuts at all next year. January is completely off the table, and there's roughly a 40% chance that the next rate cut could show up at each meeting throughout the year. Jeffrey Gunlach of double-line capital said, quote, there's a lot more confusion now than there was a couple of months ago regarding the future path. He commented, the takeaway I got from that press conference was that

there's not going to be an aggressive cutting cycle as a base case in 2025. Risky assets and a very highly valued stock market don't like the idea that rate cuts are less likely on both sides of the mandate. That's perhaps a bit of an understatement. This was the worst Fed day since 2021 for the S&P 500, which plunged by almost 3%. The NASDAQ was down 3.5%. Bitcoin saw a massive 6% sell off and all coins were a complete bloodbath. Although this was a gigantic movement, which was a gigantic move for risk assets, many noted that it looked like a correction rather than a trend change. U.S. stocks have been running extremely hot since the election, and we all know, of course, how well Bitcoin has been performing. The pullback in the S&P was only strong enough to return

to the 50-day moving average. Bitcoin found support at the $100,000 level. Currently, this move is more about handing back recent gains rather than the end of the bull run. That doesn't mean the trend can't break, but there's no evidence of it yet. Mark Lushini, the chief investment strategist said Janie Montgomery Scott said, the cut wasn't surprising. There was almost a 100% probability priced in. But I think there was some concern about the language that accompanied the news, not just about the data, but also the policy initiatives of the upcoming administration. The market was expecting two or three cuts next year and leaning more heavily towards three. Now it seems like we should be on the lighter side of two. The market is factoring in something

that should have been known but wasn't fully baked in. I think this is a bit of an overreaction and knee-jerk move off something that should have been known. It isn't like the market was shocked by an indication of just one cut next year. So it seems a bit overdone. Jamie Cox's managing partner at Harris Financial Group believes this is a healthy correction, stating, the stock market got way over its skis ahead of this meeting, and this is a good way to shake some people out before the holidays. Stocks are expensive, especially tech shares, so people are quick to sell and lock in profits ahead of the holidays.

The rate decision was just a catalyst to get people to do what they were going to do anyway. Sell early and be done after a stellar year in the stock market. Indeed, even with yesterday's pullback, the S&P is up 24% for the year, and the NASDAQ has seen 31% gains, both well above average. Trader Tony Greer said, We had a historic long position in futures, that length has to get blown out somewhere. I think the real thing to think about is that leverage has to come out.

Bitcoin to 107 with abundant liquidity, everybody's leverage to the hilt. It was literally everybody out. Underlying the drawdown in risk assets was a big shift in macro conditions. The volatility index or Vick saw the largest spike since the August Yen-Carray trade onwind and from much lower levels. That by itself is enough to take leverage down. The dollar surge to reach a fresh multi-year high, bond yields are up across the yield curve with a 10% now at 4.5%, up from a low of 3.6% in September. This was a broad readjustment

across all markets, digesting a major change in Fed expectations. The one notable indicator that didn't move was the state of the yield curve. The rate adjustment was uniform along all maturities keeping the yield curve relatively flat. This suggests that while macro conditions tightened substantially, the risk of a crisis didn't materially change. That said, this is the first time long-term rates have risen during a cutting cycle, so something is clearly a little off. So, where to next for markets now that they can't rely on support from the Fed? Obviously, red across all the screens has a big psychological impact. The question is where we go from here.

Does this escalate, or is it a one-time repricing? Warren Pies of 3F Research believes there's a little bit of 3D chess going on. Remember what happened last summer that led to the September cut, same playbook happening now? By upping the inflation forecast, lowering the unemployment rate and keeping cuts in place, the Fed has actually opened up the path to more than two cuts in 2025 as data surprises to the dovish side. Nick Timmeros of the Wall Street Journal, though, is unconvinced.

Responding, it's true that raising the forecast in such a manner means there's a high bar to resume hikes, but one important difference between June and today is the massive swing in how officials see the balance of risks waited now to the upside around their higher inflation forecasts. The number of participants who saw the risks of their forecast waited to the upside went from three in September to 15 today. Unsurprisingly, prominent bitcoiners are not convinced that this is the end of the cycle. Former hedge funder James Levisch wrote,

If you're selling your Bitcoin in reaction to what the Fed said today, you have no idea what you own. All in all, it's really just an uncertainty story. The Fed doesn't know what happens next because the next administration is unpredictable. And so it's doing what it effectively promised with this cut and turtling up. That's all there is to it. And I don't think it's worth trying to suss out too much more beyond that. Still a quietly consequential meeting for sure and an interesting end to 2024. That, however, is going to do it for today's breakdown. Appreciate you listening as always. And until next time, be safe and take care of each other. Peace.