The Breakdown - Fed Officials Say Interest Rates to Remain Higher for Longer

Starting point is 00:00:00 It's a little bit of saying the quiet part out loud. On the one hand, I think it's good that the Fed is grappling with the fact that this is more than just a normal moment of inflation and may reflect a new set of constraints that should shape monetary policy going forward. On the other hand, central banks seeing their only option as using the blunt hammer of demand destruction to address it doesn't necessarily get the blood flowing. Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and big picture power shifts remaking our world. The breakdown is sponsored by nexo.io, circle and crack it, and produced and distributed by

Starting point is 00:00:38 coin desk. What's going on, guys? It is Tuesday, November 29th, and today we are catching up with the Fed. 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, well, today we are going to catch up on the macro side of things.

Starting point is 00:01:05 Specifically, we're going to check in to see how the Fed is talking about where they see markets right now and how markets are reacting to it. Now, when it comes to the crypto-contagion story, not much has changed since yesterday. There is still a conspicuous lack of updates from Genesis and digital currency group, although some amount of doom posting has subsided. Whether that's because there's new information or simply declining engagement with that doom posting, it's not exactly clear. Still, for those looking for a sliver of hopium, yesterday, Masari's Ryan Selkis wrote, I am 90% confident that Genesis does not need

Starting point is 00:01:39 to go into Chapter 11. That would be a strategic choice, but not a necessity. Beyond that, the most interesting follow-up to yesterday's contagion stories is a bit of bankruptcy, Ted-a-Tet, between BlockFi and FTX. If you listen to the show yesterday, you know that BlockFi filed for Chapter 11 on Monday. Well, on the same day, they also sued Sam Bankman-Fried. Their complaint is aimed at emergent fidelity technologies, which is one of Sam's wholly owned holding companies. The suit is demanding that emergent, aka Sam, turn over quote-unquote unspecified collateral, which would be interesting on its own. However, according to loan documents seen by the Financial Times, the collateral in question is SBF's Robin Hood shares.

Starting point is 00:02:19 Remember, earlier this year, Sam bought about 7.6% of Robin Hood, which sparked massive rumors that he was going to try to acquire the company outright. So here's the core of the suit. BlockFi claims that on November 9th, which was of course when everything was falling apart for FTX, but a couple days before its bankruptcy, Emergent signed an agreement to guarantee Alameda's obligations to BlockFi pledging a certain common stock as a security. What it appears like from the outside and looking back was that as Sam was frantically trying to save FTX and Alameda from crumbling under their own weight, he tried to get BlockFi to chill out on calling dues some of Alameda's debts by pledging his Robin Hood stock as collateral.

Starting point is 00:02:55 Now, importantly, earlier this month, FT also reported that. that based on signal messages they had seen, SBF had at the same time been trying to sell his Robin Hood shares to various parties directly. Those sale attempts continued right on through signing this pledge all the way until the evening of November 10th. However, whatever deal BlockFi thought it had was shot all to hell when FTX filed for bankruptcy. When BlockFi tried to collect the collateral, a London-based brokerage called ED&F Man Capital Markets refused to transfer it, quote, absent an order from the bankruptcy court. Now, obviously this is a spicy little side story. It shows one that Sam was frantically scrambling,

Starting point is 00:03:31 which was pretty clear during the whole episode. Two, that he continued to deceive or at least play loose with the truth around his counterparties while doing it, signing this pledge and then still trying to sell the stock separately as well. And third, that this is just going to get messier and messier and that basically the lawyers are the only winners from this bullshit bonanza. Anyway, let's talk about some broader market stuff now. Here's how I would sum up where things are. At the last FOMC, Fed Chair Jerome Powell intimated that the terminal rate might have to be higher than they had previously thought. That made markets sad. However, then we got a lower than expected inflation print, right as FTCS was collapsing. This made markets happy. Although, of course,

Starting point is 00:04:10 none of us in crypto got to enjoy that. Now, we haven't had a chance to dig into this inflation print very much, but there are some reasons to be suspicious of just how encouraging the story is. specifically there are some base effects in terms of how things are calculated around health care costs that may be responsible for a lot of the dip. But I digress. For the purposes of this story, markets were happy. Then we got FOMC meeting minutes from that previous meeting, and there was some more room for optimism because it seemed like there was more debate around the terminal rate than

Starting point is 00:04:39 Powell's comments had made it seem. So that was the state of play coming into this week. Now previously, at this point in the micro cycle we've seen all year over and over again, the Fed would trot out a bunch of speakers to say some version of, hey, don't get too far ahead of ourselves. There's still a lot of work to do, et cetera, et cetera. So is that what we got? Speaking on Monday with Market Watch, Federal Reserve Bank of St. Louis President James Bullard said that financial markets are underestimating the chances that policymakers will need to be more aggressive next year to tame inflation. He said, quote,

Starting point is 00:05:09 markets are underpricing a little bit the risk that the FOMC will have to be more aggressive, rather than less aggressive, in order to contain the very substantial inflation that we have in the U.S. Bullard confirmed his view that the Fed would need to take interest rates to at least 5% and possibly as high as 7% in the coming year. Quote, we've got a ways to go to get restrictive. Now, many noted that this was the same phrase that his colleague Fed Governor Christopher Waller used a few weeks ago, ways to go. Bullard's view was that rates would have to say restrictive for all of 20203 and 2024,

Starting point is 00:05:38 given the historic behavior of inflation, which often has come back stronger as soon as the Fed backs off. The Fed has already hiked its policy rate by 375 basis points this year. year, which is the fastest tightening cycle since 1981. Speaking on how aggressive the Fed should be moving forward, Bullard said, I do think that the fact that the labor market is so strong gives us license to pursue our disinflationary strategy now and try to get the inflation under control right now so we don't replay the 1970s, where the FOMC at that time took 15 years to get inflation under control. If you've been listening to this show at all for the last couple

Starting point is 00:06:11 months, you will see the same themes that have come up over and over again. One, we don't want to fall into the traps of the 1970s, where they took their foot off the break too fast. And two, given how strong the labor market seems, we don't feel any need to stop tightening any time soon. Now, when it comes to whether he expects a recession, he said that his base case was slower growth, but not necessarily recession. And hawkish, though Bullard was, he also said that he would defer to Powell in choosing how much to hike meeting to meeting. Many in the markets interpreted this that he's going to get behind 50 basis points instead of the 75 basis point hikes we've had for the last few meetings, if that is ultimately what the decision is. So that's our first Monday Fed speaker,

Starting point is 00:06:51 but were there others. Indeed, there were, in fact, no less than four speakers came out on Monday. Fed Bank of Richmond President Thomas Barkin was on Bloomberg. He gave sort of a mixed review of where things were, saying that he thought the pace of increases might need to be slowed, given how aggressive they'd already been this year, but also that the peak might need to be held for longer at higher levels. This obviously reinforced the message that had made the market sad at the last FOMC. He said, quote, I'm very supportive of a path that is slower, probably longer, and potentially higher than where we were before. Barkin also said that he expects peak rates, certainly, that's his word, to be higher than he had previously thought.

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Starting point is 00:09:03 Buy crypto instantly with fast, flexible funding options on Cracken. Download the Cracken app on Google Play or the Apple App Store or visit crackin.com to join. New York Fed President John Williams spoke at an event for Economic Club New York, and also reinforced that the Fed's expectations of the difficulty of taming inflation had increased up since September. Quote, stronger demand for labor, stronger demand in the economy than I previously thought, and then somewhat higher underlying inflation suggests a modestly higher path for policy relative to September. Not a massive change, but somewhat higher. Williams went on to say that, quote, his baseline view is that we're going to need to raise rates

Starting point is 00:09:45 further from where we are today. And that, quote, we're going to need to keep restrictive policy in place for some time, meaning probably at least through 2023. Cleveland Fed President Loretta Mester did an interview with the Financial Times that was also published Monday and reinforced that we're nowhere near a pivot. The Financial Times asks, what specifically do you consider compelling enough evidence to, let's say, consider pausing the rate rises? And how does that compare with the threshold for cuts? Mester responded, I don't think we're near a pause.

Starting point is 00:10:14 Given we're beginning to move into restrictive territory, we have the opportunity to slow the pace of increases and evaluate the effects and make sure we're being very diligent in setting monetary policy to return the economy to price stability, but also judicious in balancing the risks to minimize the pain of the journey back to price stability. We had one good October CPI report. I would need to see several more of those and more moderation and perhaps even a reduction in core service prices. And we also have to see better balance in the labor market. Right now, there are signs that labor market conditions are moderating on the demand side, but we still have pretty high wage pressure. We need to have more evidence coming that things are

Starting point is 00:10:48 moving in the right direction. It's very easy to be caught out by the good news, but we don't want wishful thinking to take the place of really compelling evidence. The cost of stopping too early are high. We want to be very diligent about this. So as you can see, this is a pretty unanimous message. Kerberos-O-O-7 wrote today, Powell sent not one but four officials to give a unanimous caution on the December fomc. In summary, there's no imminent slowdown, definitely no pivot in sight. Black Lion CTA writes, I've never been a huge Bullard fan, but if he's he is a stalking horse for Powell's Wednesday remarks, it is going to make Jackson Hull sound like a tea party. Now what he's referring to is a upcoming speech at the Brookings Institute on Wednesday,

Starting point is 00:11:27 which will be nominally focused on the labor market. The speech, which will be one of the last speeches delivered by a Fed official prior to the December FOMC meeting blackout period, is tip to be used to reinforce the message delivered by other Fed speakers recently. This message appears to be that the Fed will slow its rate hikes, only delivering a 50-bases-point hike in December, but that this should not be viewed as a pivot or the Fed abandoning its fight against inflation. Julia Coronado, the founding partner at macro policy perspectives, said, quote, he's probably going to use the speech to be hawkish and describe the dimensions of imbalance in the labor market, and that this could be, quote, a reason that they need to be committed to a tight policy for

Starting point is 00:12:01 longer. Now, there are some disagreements in how to interpret all of this. On the one hand, there are some like Mateo Marinelli, who wrote, regarding the words of Bullard, I wonder how the market could be so surprised. Did participants really think the Fed was about to pivot? it? Higher for longer, it's literally what's been repeated since this summer, and the higher the terminal rate, the lower the valuations. Others, however, are calling BS. There is a lot of trader sentiment that despite the Fed's tough talk, the market just doesn't believe they have the conviction to do what's necessary. Essentially, the market participant tone is that they're not disregarding the Fed's resolve. They just don't think there's going to be near enough desire to

Starting point is 00:12:36 hike to 5% or hold it there during a recession. Now, there's one other Fed speaker for Monday who wasn't actually speaking on Monday. Yesterday, the Federal Reserve released comments made by Vice Chair Lail Briner during a Bank for International Settlements Conference held back in June. During that discussion, the vice chair explores the possibility that inflation will be more volatile in the coming decades and looked at the implications that macro regime shift would have on central bank policy. She points to changes in the global economy, including demographic decline, de-globalization, and climate change, and how they could cause more frequent and severe supply shocks, which would force a change

Starting point is 00:13:10 in the way central bank economists think about the resilience of the global economy. Brandenard said, quote, In the presence of a protracted series of supply shocks and high inflation, it's important for monetary policy to take a risk management posture to avoid the risk of inflation expectations drifting above target. A drawn-out sequence of adverse supply shocks that has the cumulative effect of constraining potential output for an extended period is likely to call for monetary policy tightening

Starting point is 00:13:32 to restore balance between demand and supply. Brayard said that inelastic supply is what differentiates this post-pandemic recovery from other periods over the last 30 years. quote, a protracted series of adverse supply shocks could persistently weigh on potential output or could risk-pushing inflation expectations above target in ways that call for monetary policy to tighten for risk management reasons. Essentially, what Vice Chair Brainer was trying to convey is that forces which can't be affected by monetary policy, such as labor scarcity, de-globalization, and commodity market dislocations could place central banks in a position

Starting point is 00:14:05 where they need to reduce demand in a permanent manner in order to meet permanently constrained supply. The alternative to this forcibly reduced standard of living would appear to be much higher and more volatile inflation alongside shortages. So I think this speech is really notable and probably worth even more time than we have today. It's a little bit of saying the quiet part out loud. On the one hand, I think it's good that the Fed is grappling with the fact that this is more than just a normal moment of inflation and may reflect a new set of constraints that should shape monetary policy going forward.

Starting point is 00:14:35 On the other hand, central banks seeing their only option as using the blunt hammer of demand destruction to address it doesn't necessarily get the blood flowing. Anyway, all in all, I think there is a clear message coming through, and it is, in fact, the same thing that we've seen in this microcycle over and over and over again. Tiny little bit of good news or simple boredom leads the market to get ahead of itself, which has the Fed trot out a bunch of speakers to try to get it back in line, and then around and around we go. Now, when it comes to this question of recession, we're getting kind of mixed signals. There are certainly signs of a global slowdown, continuing to show up across a range of indicators. Both China and the U.S. exports saw contraction in

Starting point is 00:15:13 October, with the American data below normal range. Global container volumes fell by 8.6% in September, reaching their lowest level since February, and doing so during the period where shipping is usually its annual peak demand. There's also yield curve inversion, if you're looking for wonky signals, which happens when short-term rates are higher than longer-term rates, and tends typically to be a strong predictor of an incoming recession. Charlie Belayo wrote, the three-month Treasury bill yield is now 0.73% higher than the 10-year Treasury bond. In the last 60 years, only periods with a more inverted yield curve are 2000 to 2001, recession in 2001, 79 to 82, recessions in 1980, 1980, 1982, 1973 to 1974, recession in 73 to 75. But all the data is not pointing this

Starting point is 00:15:58 direction. For example, the American consumer is still spending. Black Friday sales were solid, if not excessive. In-store traffic was up 2.9% compared to last, year while online sales were up 2.3%. With inflation running at almost 8% in the U.S., these numbers should reflect fewer goods sold, but nominal sales are not showing anything close to a collapse in consumer demand. Jim Bianco wrote, this is bad news for stocks. They want a recession so the Fed will stop hiking and then start cutting soon afterwards. The stock market is a liquidity junkie. It needs lower rates more than it needs better earnings. So friends, that is the story from here. I'm sure we'll have a lot more to talk about on this front after Powell's remarks tomorrow.

Starting point is 00:16:37 and of course after Sam's New York Times deal book appearance. So expect some fireworks for the rest of this week. For now, I want to say thanks again to my sponsors, nexo.io, Circle and Cracken for supporting the show. And thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace.

The Breakdown - Fed Officials Say Interest Rates to Remain Higher for Longer

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