The Breakdown - Fed’s Powell Brings the Dog and Pony Show to DC for the Semiannual Monetary Policy Review

Episode Date: March 9, 2023

In today's episode, NLW looks at the macro as Federal Reserve Chair Jerome Powell discusses monetary policy this week before Senate and House of Representatives banking committees. The markets are betting on a 50 basis point rate hike at the next Federal Open Market Committee meeting based on his Tuesday comments. Enjoying this content?   SUBSCRIBE to the Podcast Apple:  https://podcasts.apple.com/podcast/id1438693620?at=1000lSDb Spotify: https://open.spotify.com/show/538vuul1PuorUDwgkC8JWF?si=ddSvD-HST2e_E7wgxcjtfQ Google: https://podcasts.google.com/feed/aHR0cHM6Ly9ubHdjcnlwdG8ubGlic3luLmNvbS9yc3M=   Join the discussion: https://discord.gg/VrKRrfKCz8   Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW   - “The Breakdown” is written, produced and narrated by Nathaniel Whittemore aka NLW, with editing by Michele Musso and research by Scott Hill. Jared Schwartz is our executive producer and our theme music is “Countdown” by Neon Beach. Music behind our sponsor today is “Foothill Blvd” by Sam Barsh. Image credit: Anna Moneymaker/ Getty Images, modified by CoinDesk.  Join the discussion at discord.gg/VrKRrfKCz8.  

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 produced and distributed by CoinDes. What's going on, guys? It is Wednesday, March 8th, and today we are heading to the macro side of the house to get caught up with Jerome Powell. A quick note before we dive in, there are two ways to listen to the breakdown. You can hear us on the CoinDesk podcast network feed, which comes out every afternoon and features other great CoinDesk shows. Or you can listen on the breakdown only feed, which comes out a little bit later in the evening. Wherever you listen, I would so appreciate it if you would take the time to leave a rating or review.

It makes a huge difference in people discovering the show. All right, guys, so as I mentioned right up front, today we are using the occasion of Fed Chair Jerome Powell's semi-annual report to the Senate about the state of monetary policy to check in with where things are in the macro realm. It's been an interesting few months where there has been so much crypto-specific chaos that it's been easy to lose sight of the fact that we are all ultimately in a risk sector that is caught up in the larger macro machinations. Now, the last time Powell testified before Congress was in June of last year. Annualized inflation was at its peak above 9%, a 40-year high, and the Fed was just three meetings into what would become the fastest tightening cycle on record.

The Fed discount rate was at 1.75%. and the previous week at the June FOMC meeting, Powell had delivered the first in a string of four gigantic 75 basis point raises. Each of those represented the largest rate hike increments seen since 1994. The tone in Congress at that time was incredulous. Democrats were concerned that accelerated rate hikes would tip the economy into a sharp recession with massive unemployment. Republicans, for their part, took the opportunity to excoriate the Fed share for moving

too slowly when inflation had begun to get out of control in late 2021. Both sides of the aisle were openly doubtful that the Fed had the tools to tame inflation. Since then, inflation has come down dramatically, clocking in at 6.4% for January and recording seven straight months of reductions at headline inflation. The Fed has taken rates all the way up to 4.75% and forecast that they are not yet considering an end to this hiking cycle. Now, when it comes to this particular conversation on the hill, right out of the gate, it was a political endeavor.

Not that you'd ever really expect that it wouldn't be. Still, the talking points around inflation have clearly become more. more crystallized on each side of the aisle in the last year since Powell spoke to the Senate. This really showed right from the opening statements. Committee Chairman Sherrod Brown, a Democrat, introduced the hearing with a long, kind of weird, rambling speech about increased corporate pricing power being the true driver of current inflation. He said, quote, the broadening of inflation beyond commodity prices is more profit margin

expansion than wage cost pressure. Brown raised concerns about the potential for Fed policy to crush the working population with increased unemployment without actually addressing the root cause of inflation. Quote, not only will higher interest rates not solve it, if they're overdone, they'll make it worse. While Brown acknowledged that the Fed has little role reigning in corporate power, he called for the Fed to talk about this issue. Quote, high interest rates, falling wages, increasing unemployment, are all hallmarks of failed policies that end up helping Wall Street, the largest corporations in the country,

the wealthiest people in the country. Let's be clear what we're talking about when people use the economic speak that can cloud this conversation. Cooling the economy means laying off workers. Lowering demand means workers get fewer raises. there are other ways we can bring prices down instead of lowering demand. End quote. While Brown certainly appeared to have conviction that the right way to cool inflation was not

to crush the labor force, the Fed is of course extremely limited in its ability to address corporate profiteering. If only there were some other part of government that was tasked with making laws that form industrial and corporate policy. Hmm. So anyways, if that's one of the key coalesced Democrat messages, what do the Republicans have to offer? Ranking Republican committee member Tim Scott used his opening remarks to contrast with

his Democrat colleagues. He called Brown's opening fascinating, truly fascinating, and concluded that he was, quote, sure Chairman Brown was sincere in his rant. Scott assessed the real problem as government excess. He said, quote, spending and printing trillions of dollars, caving to the radical left in this country, seeing policies posited and then implemented that led to the worst inflation in 40 years. It's unbelievable that the progressives in this country who caused a 9.1% inflation would then turn somewhere besides in the mirror to see the absolute devastation caused by their out-of-control spending. To stop the out-of-control inflation caused by the out-of-control spending, the Fed steps in to cool the economy. Anyways, as you can see, partisan politics in America just absolutely eats everything, and it colors all of these positions.

What's more, it is a bit of a big forcical play-acting session. Brown and Scott were almost intentionally trying to foil one another to make the lines of the debate clear. Anyway, then we got to Powell's intro. Jerome introduced the semi-annual monetary policy report with a repeat of the Fed speak we've heard at recent FOMC meetings. Fed is acutely aware of the hardship that high inflation causes. Monetary policy has been dramatically tightened with forceful actions. The full effects of monetary tightening is yet to be felt. Powell then moved on to an assessment of economic indicators, pointing out that all of the data for employment, consumer spending, manufacturing production, and inflation have partially

reversed the softening that was seen in December. Quote, the breadth of the reversal suggests that inflationary pressures are running higher than expected at the time of our previous FOMC meeting. This was Powell definitely moving even more hawkish. Powell presented the current inflation outlook that both goods at housing are showing disinflationary trends, but inflation in non-housing services is not showing any signs of cooling inflation. He noted that real GDP growth was below trend last year, while the labor market remains very strong.

Powell repeated previous guidance at the FOMC, quote, continues to anticipate that ongoing increases in rates will be appropriate. He then presented the new guidance that Fed Watchers and markets had been anticipating. Quote, the ultimate level of interest rates is likely to be higher. than previously anticipated. Powell confirmed that the FOMC would be willing to do more, quote, if the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes. In other words, Powell was saying, raise rates at 50 basis points per session rather than 25 basis points. Closing out his remarks,

Powell once again pointed out that the historical record strongly warns against backing off on rate hikes until inflation has been snuffed out. Now, what matters with things like this is all about the market's interpretation, and the TLDR was that Hawkesh Powell showed up and that the higher for longer memo finally landed. The big takeaway for markets was Powell's guidance that the terminal rate would likely be forecast higher when the FOMC meets later this month. During the hearing, the two-year treasury yield shot up, driving above 5% to its highest level since 2007. Keep in mind, the terminal rate is often closely linked to the two-year yield. Fed funds futures markets, which are typically a solid forecasting mechanism for an upcoming FOMC decision,

flip their bets. Going into the hearing, the market had priced the chance of a 50 basis point hike this month at less than 30%. Once Powell started talking about a higher terminal rate, that probability rapidly moved in is now sitting at over 60%. Meaning that markets have now priced in a base case that the Fed will go back to larger rate hikes immediately. Even more dramatically, markets are beginning to price in some probability that the Fed will need to take rates above 6% during the third quarter. The dollar index reacted strongly, gaining 1% in the hours following the hearing to reach a three-month high. Risk markets were obviously taken a bit aback by Powell's testimony. Both the S&P 500 and the NASDAQ sold off by more than 1.2%.

Bitcoin fared relatively better, falling less than 1%, but tumbled out of its tight range around 22,400 and momentarily lost the key level of 22,000. But what about other questions in the testimony? Is there anything in there worth discussing? I would say that there were two big winners in the grandstanding competition, one from each side of the aisle. One of them was Elizabeth Warren. If Sherrod Brown's job for the Dems was to lay blame for inflation on corporate greed, Warren's job was to call out rising unemployment as too high a cost for the Fed's chosen remedy to inflation. The senator from Massachusetts came firing out of the gate with a clear agenda. She said, quote, the Fed has raised interest rates eight times over the last year in what has

been the most extreme rate hike cycle in 40 years. Your tool is designed to slow the economy and throw people out of work. Her questioning was premised on the idea that inflation had a range of factors, including corporate price gouging, just like we had heard about from Sherrod Brown, as well as the ongoing war between Russia and Ukraine. Warren pointedly asked whether Chairman Powell knew how many people would lose their jobs by the end of the year based on current Fed projections. Powell said that he did not have the numbers in front of him, but that this was an unintended consequence. Obviously unsatisfied with this answer, Warren asserted that higher unemployment was in fact the obvious consequence of current Fed policy and added that two million

people were likely to lose their jobs. Arriving at her soundbite, Warren asked Powell, quote, if you could speak directly to the two million hardworking people who you're planning to get fired over the next year, what would you say to them? Powell replied, I would explain to people more broadly that inflation is extremely high, and it's hurting the working people of this country badly, all of them, not just two million. We are taking the only measures we have to bring inflation down. When pushed further, a clearly agitated Powell asked, will working people be better off if we just walk away from our jobs and inflation remains at 5 or 6 percent? Having made her point that recession is somewhat inevitable on the Fed's current

course, Warren asked if Powell can, quote, stop it at 2 million people. She said, quote, history suggests that the Fed has a terrible track record of containing modest increases in the unemployment rate. Once the economy starts shedding jobs, it's kind of like a runaway train. Regaining his composure, Powell simply stated, right now the unemployment rate is 3.4%, which is the lowest in 54 years. We actually don't think we need to see a sharp or enormous increase in unemployment to get inflation under control. Bringing her time to a close, Warren said, in other words, you don't have a plan to stop a runaway train if it occurs. Chair Powell, you are gambling with people's lives. You cling to the idea that there is only one solution,

lay off millions of workers. We need a Fed that will fight for families, and if you're not going to lead that charge, we need someone at the Fed who will. Now, there are a lot of people who rightly point out how much of Elizabeth Warren's position here comes from her political image-making versus any real understanding of the economics. However, there is an underlying question that's probably worth asking. One of the most farcical aspects of all of this is that monetary policy is being asked to fix a problem almost entirely on its own that was not entirely of its own making. Yes, it's quite clear that the Fed deserves their share of blame for taking an entire year off of raising rates under the banner of inflation being quote-a-quote transitory.

However, the root causes of inflation involves some combination of supply demand mismatch following dislocations from COVID, fiscal policy which put excess money in the hands of citizens, and more. Now, however, the only tool being used to fight inflation is monetary policy. The only string Powell has to push on is demand destruction. As Powell has often pointed out, he can't make it so that there's more supply of things. His only tool is to make it so people can't buy things, so they stop buying them and so prices for them come down. That's obviously oversimplified, but not really that much in essence. The damnable thing about that is that the tools that Powell has to do this are basically going to hurt the most for the same people that inflation is hurting the most. Join CoinDesk's Consensus 20203, the most important conversation in crypto and Web3, happening April 26 through 28th in Austin, Texas.

Consensus is the industry's only event bringing together all sides of crypto, Web3, and the Metaverse. Immerse yourself in all that blockchain technology has to offer creators, builders, founders, brand leaders, entrepreneurs, and more. Use code breakdown to get 15% off your paths. Visit consensus.coindex.com or check the link in the show notes. By the way, Powell kind of caught this from the other side of the aisle as well. Senator Kennedy started by pressing on the Republican talking point of out-of-control fiscal spending, suggesting that reducing government spending could assist the Fed in bringing down inflation.

But then he put to Powell, quote, when you're trying to slow the economy, you're trying to put people out of work. That's your job, is it not? Agitated Powell responded, we're not trying to raise the unemployment. rate. We're trying to realign supply and demand. That could happen through a bunch of channels, for example, job openings. Kennedy came back at Powell, presenting the history of periods where the Fed has achieved disinflation, which typically came with rises in unemployment alongside recessions. Kennedy said, if history is right, unless you get some help, in order to get inflation down

from 6.4 percent to 4.4 percent, the unemployment rate is going to have to rise to 7 percent, based on history. Powell agreed, stating that is what the record would say. Kennedy reached a crescendo suggesting, quote, the only way we're going to get the sticky inflation down is to attack it on the monetary side, which you're doing and on the fiscal side, which means Congress is going to have to to reduce the rate of growth of spending and reduce the rate of debt accumulation. The more we help on the fiscal side, the fewer people you're going to have to put out of work. Seemingly tired of the line of questioning, Powell conceded it could work out that way. Now, what about other topics of interest from this long hearing?

Crypto did make a few appearances. Senator Brown was the first to bring up crypto during the opening salvo of questions for the hearing. He asked Powell how the Fed is going about evaluating the risk of crypto-related activities within the banking sector. Powell responded that the Fed had been quite active in that area, but warned that the Fed does not want to stifle innovation, noting that this would have the effect of favoring incumbents. He did not mince words, saying, quote, we've been watching what's been happening in the crypto space, what we see is quite a lot of turmoil, we see fraud, we see a lack of transparency, we see run risk. He characterized the actions of the Fed as simply ensuring that regulated banks

are being careful and giving regulators notice of their crypto-related activity. Senator Cynthia Lummis asked about the paradox of the Fed's position on stablecoins. She noted that the Fed as a member of the president's working group on financial markets had called for bank-like regulation of stablecoins in 2021. Then this year published the guidance that a bank issuing a stable coin on a public blockchain is highly likely to be inconsistent with safe and sound banking practices, their words. Powell attempted to clarify the Fed's view. Quote, I think there are real concerns about permissionless public blockchains.

The reason is that they've been so susceptible to fraud, to money laundering, and all of those things. Lumas asked if there was a place for well-regulated stablecoins, to which Powell said, I think in a world of appropriate regulation, where stablecoin activity gets the same regulation as comparable products, there could be a place for stable coins in our financial services sector. Lumas pointed out that many other jurisdictions are standing up crypto regulations. She asked if the U.S. is at risk of being a rule taker rather than a rulemaker when it comes to digital assets. Powell responded, I do think it would be important for us to have a workable legal framework around digital activities. I think it's important in something Congress and

principle needs to do because we really can't do that. It's nice to see Senator Lummis pushing here a little bit, especially given that the Fed has taken an active role in Operation Chokepoint 2.0, given their recent joint statements about why banks should be cautious servicing crypto companies. Anyway, trying to sum this up, I think the big thing is that higher for longer is finally sinking in. Powell seemed to forecast 50 basis points is in range for the March 16th FOMC meeting, and that a higher terminal rate forecast is coming. Totally unexpectedly, bipartisanship is completely gone. Dems blamed. corporate profits, the GOP blames fiscal excess, and both seem happy to wield inflation as a cudgel rather than actually addressing it. Now, in terms of whether that 50 basis points could be walked back

and whether we might see only a 25 basis point hike, most market commentators think that we're going to need to either see a cooler than expected jobs report, which is due next Friday, or a pretty significantly cold CPI report, which is also coming out next week. Until then, the Hawks are ruling the roost. All right, guys, that's the macro outlook from here. Appreciate you listening, as always, and until tomorrow, be safe and take care of each other. Peace.