The Breakdown - Have We Passed Peak Inflation?

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. The breakdown is sponsored by nexus.com, and ftX, and produced and distributed by CoinDesk. What's going on, guys? It is Wednesday, August 10th, and today we are talking about inflation. 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 dig 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. Also a disclosure as always, in addition to them being a sponsor of the show,

Starting point is 00:00:46 I also work with FTX. And finally, this week I am thrilled to welcome NEAR as an additional sponsor. Near is a revolutionary yet simple Web3 platform for building decentralized apps. Designed by developers for developers, over 700 projects are now building on NIR's fast, secure, scalable protocol. Whether you're a crypto-native launching defy apps, NFT marketplaces, or play and earn games, or looking to migrate your project from Web 2, NIR makes it easy to build Web 3 for the masses. NIR offers developers a variety of tools, resources, and support for building apps, empowering communities, and creating a more fair, inclusive, and equitable future. Start your Web3 developer journey now by visiting NIR at nir.org. All right, it is CPI Day Baby. Yesterday, we

Starting point is 00:01:32 set the frame of this inflation print a little bit, but the quick TLDR is that at the last FOMC meeting, the Federal Reserve ended or at least paused forward guidance. This means that instead of the Fed telling us what they thought they would likely do with interest rates in the months to come, they were simply going to wait for data to guide their decisions. Now, one part of the data that they were likely to be interested in was around jobs in the labor market. One of the reasons the Fed gave for letting inflation run hot in the first place was a desire to see more people participate in economic recovery post-pandemic. The rhetoric around this has now shifted, and the Fed has made clear that they are willing to see a softening in the labor market,

Starting point is 00:02:14 aka unemployment rising, if it means that their policies are working to bring down inflation. The much bigger piece of data that they care about is inflation. This is the big driver for monetary policy decisions. Whether the Fed is actually going to be successful in bringing inflation down is likely to be the biggest driver for any monetary policy decisions going forward. Of course, at the beginning of each month, we get to find out what inflation was for the month before, and so that has been all of the discussion for the past few days. Coming off of the last FOMC meeting, the big theme was that the Fed is past, quote, peak hawkishness. This was driven in specific by the press conference that happened after the meeting, where Powell

Starting point is 00:02:55 said that the Fed saw themselves now in neutral territory, aka in a.k.a. in a.m. a place where the federal funds rate was no longer contributing to the overheating of the economy. When markets heard that, they took it as a clear sign, clearer likely than the Fed wanted, that peak hawkishness was behind us. Now, to some extent, the markets were cherry-picking commentary and picking out what they wanted to hear. Jerome Powell made it clear in the same press conference that if inflation data remains stubborn, the Fed was perfectly willing to raise rates as aggressively as they believed necessary. Indeed, a lot of the Fed's commentary since that meeting has been trying to reinforce the message that they will do what it takes, and that the market

Starting point is 00:03:32 might have been getting ahead of itself in terms of their confidence about a shift in policy. So let's discuss expectations. The average estimates of the inflation print were coming in at 8.7%. And really, most of the big investment houses and banks were clustered around that number. Obviously a high number, but it would have been lower than the 9.1% we saw last month. What about the big themes in the discussion, though? Three really stand out. The first has to do with oil and gasoline. The second has to do with housing. And the third is the supremacy of core over headline inflation. To speak to gas first, the biggest part of the optimism

Starting point is 00:04:09 for this particular headline decrease is that we've now seen weeks of declines in the price of gas. Markets have been watching these price decreases and factoring that into how they see inflation changing. Goldman Sachs wrote, the most immediate reason to expect disinflation is the nearly 20% decline in retail gasoline prices since mid-June, which still has further to run. By itself, this decline should take at least one percentage point off the headline CPI level in the next two to three months. Now, others thought that gasoline isn't a big enough part of the headline CPA basket to make that big of a difference. Total energy is somewhere between seven and a half and nine percent of the headline basket, and within that, gasoline makes up just about four percent.

Starting point is 00:04:50 Part of the reason that gasoline looms so much larger is that energy prices, oil prices, gas prices, are one of those things that people experience viscerally, especially with gasoline, as so many of us fuel up week in and week out. The second big theme in the discussion leading into today's inflation numbers was the potential for a lag in housing price changes. Lin Alden tweeted inflation data related to shelter continues to be on a steady upswing. That's something I isolate out in each CPI print to see what it's doing. It doesn't go up as quickly as actual house and rent prices and instead takes time to get there. Patrick Sanner, the head of macro business at the Swiss Reinsurance Group, writes,

Starting point is 00:05:27 rent in OER equals about 30% of CPI, energy equals about 9% of CPI. Energy-related inputs will probably start falling on a year-over-year basis, but rental inflation will stay elevated for another few quarters at least providing ongoing core CPI pressures. Jeffrey Gunlock tweeted, A relative of mine in Middle America just had a rent contract expire. The re-up for the next 12 months is up over 40% from last year. Let's see how far from reality the shelter component of the CPI is tomorrow.

Starting point is 00:05:56 Now, I think it's worth spending a minute on the construction of this. On the one hand, part of me viscerally responds to arguments that are some formulation of, a person I know is experiencing this, and that experience must be more correct than the data. But when it comes to the economy, I think this sort of narrative making is even more potent and powerful than in other contexts. One of the reasons that the Biden administration has such a hard time with this economy, politically speaking, is that they look woefully out of touch every time they try to say, look, the data says things aren't as bad as you feel they are. Telling people that their feelings and lived experience is invalid is a tough proposition politically. And what's more, when it comes to the economy, the aggregate sentiment has a self-fulfilling prophecy aspect to it.

Starting point is 00:06:38 If the general perception of the economy remains poor, then people make decisions based on those feelings. In fact, the average person is far more likely to make a problem. make financial decisions based on sentiment than they are on data. Regular people aren't tapping their fingers waiting for 830 to come to see what the inflation numbers are. They're living inflation in real life. And their own lived experience filtered through the lens of broad perception they see reflected in media is what's going to shape their decisions. Anyway, the short of this is that rent and housing costs have a lag in how they show up in this data. And so even as gasoline prices start to decline, and that gets reflected in the inflation data, it might be that

Starting point is 00:07:13 there's also a different force continuing to push up in terms of increases in housing costs. In times like these, security of your assets should be your number one priority. If you want to offset risk as much as possible and still stay in crypto, you need a trusted partner by your side. Nexo is a security-first company that manages risk by relying on mechanisms such as over-collateralization, real-time auditing, and insurance on custodial assets. Learn more about Nexo's reliable business model and start your crypto journey at nexo.io. That's nexo.io. Eager to make more informed decisions around crypto, chainalysis is here to help.

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Starting point is 00:08:38 There are no fixed minimum fees, no ACH transaction fees, and no withdrawal fees. One of the largest exchanges in the U.S. FtX U.S. is also the only leading exchange that supports both Ethereum and Solana NFTs. When you trade NFTs on FTCS, you pay no gas fees. Download the FTCS app today and use Referral Code Breakdown to support the show. The third big theme in the discussion is that it is all about core. The wisdom everywhere was ignore headline numbers and look at core. Core inflation excludes some of the most volatile aspects of the headline inflation, including energy and food, and is what the Fed is more concerned about. Gareth Salloway tweets, folks, stop paying attention to the headline CPI number that retail watches and start paying attention to the core CPI number that big money watches. That is the key. Core is what will dictate the Fed's next move, not headline. Stop thinking like average investors and step up to the

Starting point is 00:09:34 next level. Alex Kruger agreed, writing, focus on core, that's the big incognita. Market knows headline is coming down hard, even more so next month due to gasoline. Core on the other hand, has everyone concerned. If core comes in greater than consensus, think short-term trend turns down. Now, in the days leading to last month's print, the market started to get a signal that inflation would be coming in hot. The White House started spitting a full 48 hours before the inflation numbers actually came out, talking about lagging data and how gasoline was already coming down. This time, we didn't get any such spin. Jared Dillian writes, A reminder that last time, the White House got the CPI print ahead of time and warned us it was

Starting point is 00:10:14 going to be high. No warning yet. Does that mean it's going to be low? Well, that is indeed sort of what we got. At 8.30 a.m. on the dot, in all caps, Joe Wisenthall from Bloomberg tweets, breaking. It's cool. Zero percent headline inflation. Core rises just 0.3%. S&P futures shoot higher. Headline had been expected to rise 0.2% month over month. Economists had been looking for a 0.5% core gain. So let's break this down. The headline year over year inflation, was 8.5% versus the 8.7% that was expected and 9.1% last month. Core CPI was 5.9% year over year. However, the month-over-month numbers were even more encouraging. Month-over-month headline data was actually flat. In fact, if you don't round, it was actually

Starting point is 00:11:03 a little under zero. This is after a 1.3% increase in June. Core was up 0.3%, which was down from a 0.7% gain in June. This was the first downside surprise relative to Bloomberg consensus since August of last year. The decrease was driven as expected by gasoline. Gas was down 7.7% in July, but other areas were surprisingly down as well. Utilities were down 3.6 from the prior month, airfare down 7.8% from the prior month, which is its biggest decrease in almost a year. Hotels and used cars were also down. Now, on the flip side, food is still really expensive, up 10.9% over a year, and shelter costs

Starting point is 00:11:43 continue to rise, up 0.5% on the month and 5.7% from last year. In spite of that, however, markets were pumped. S&P futures were up 2 plus percent. Bitcoin also followed and was up about 2% instantly. Joe Wisenthall again pointed out that this was actually the fourth month in a row of a decline in the year-over-year core inflation rate. So, as you might expect, there was a lot of peak inflation-confirmed type of conversations. Now, one common theme that I did want to point out is that there are a lot of people tweeting some version of, we're stupid to celebrate 8.5% inflation. My feeling on this is sort of, come on, man. People are smart enough to get that markets reacting positively to this isn't because they think 8.5% inflation is good, but because of the direction

Starting point is 00:12:29 it seems to be headed. Put differently, there's no path to whatever we think a healthy, normal inflation level is without going through all the other numbers in between. It's just triton doesn't really add much to the conversation to be like, yeah, but 8%, 7%, 6%, 6%,000, inflation is still bad. We know, but that's not the point. The point, at least for the moment, is the trend line. That said, there are better concerns than that sort of concern trolling about 8.5% still being bad. First, we had the rational still have a long way to go type takes. Claudia Sam wrote about time we got a downside surprise on inflation. Take a deep breath and know we still have a wild ride ahead, sadly. That said, I am thrilled to have the first CPI day in a long

Starting point is 00:13:10 time where I don't feel like puking all day. Second, there are many arguments that shelter isn't really well reflected. Charlie Bielo points to average monthly rent data from apartment lists that suggests rent is up 12.4% year-over year, and the K. Schiller U.S. National Home Price Index, which suggests that home prices are up 19.7% year over year. Third, there remain big concerns about stagflation. Clinton-era Treasury Secretary Larry Summers has been all over TV talking about why he worries that a slowdown and headline inflation will lead the Fed to believe that their policies are working and that their job is done. Speaking with Bloomberg last week, Summers said, quote, I'm afraid if we have some good news on non-core inflation, that, combined with signs of an

Starting point is 00:13:51 economic slowdown, will lead the Fed to think things are under control. We're going to have a situation like we had in the 70s, where we've perpetuated inflation by not doing enough to contain it. We have by any reasonable measure core inflation somewhere in plus or minus 5%. It's more than when Richard Nixon implemented price controls. This is not acceptable by any dimension. I don't think the Fed has the wire right now. Without significantly raising real interest rates which are adjusted for some measure of inflation, then we are just setting the stage for stagflation. Paul Krugman sort of agreed, saying the good news we are about to get on near-term inflation is not proof that the strategy has ever worked, and alas, it offers no justification for an easier pivot

Starting point is 00:14:29 to money. Now, part of this stagflation argument is about productivity. The Labor Department figures released on Tuesday showed that productivity, which is a measure of non-farm business employee output per hour, had fallen at 4.6% annualized in the last quarter after falling at a 7.4% pace in the first quarter of the year. These are the weakest back-to-back results since 1947 and the largest year-on-year drop in output on record. Ben Hunt tweets, in the first six months of 2022, as real economic output contracted, while labor costs expanded faster than inflation, labor productivity declined at the fastest rate since recordkeeping began in 1948. This is textbook stagflation.

Starting point is 00:15:08 It doesn't matter whether you call this a recession or not. Our economy is rotting from the inside out, as real growth contracts, even as wage price expectations expand. You can't fix both sides of this equation at the same time, but my fear is that we will fix neither. Whatever the case, it hasn't stopped the political spinning from going hard. The Biden official Twitter account tweeted, last year one-third of core inflation was due to high prices for automobiles because of the shortage of semiconductors. With the chips and science law boosting our efforts to make semiconductors right here at home, America is back leading the way. So what next from here? Some people were willing to hazard a guess. Raoul Paul writes,

Starting point is 00:15:46 markets now have a pretty clear run until regional Fed surveys in a week or so. I expect those to be significantly weaker. Peak inflation gives way to peak growth fear. I do think markets will react positively to weak growth, not negatively broadly speaking. But more or less, from my standpoint, I think that we are about to see a lot of the same debates over and over until there's some new data to shape the discussion. What's more, the closer we get to November and the midterms, the more politically charged the positions are going to be. But for now, it's green on the day. People are excited. People are feeling good. Inflation looks like it turned a corner, although one month is too early to call that a trend. So all in all, not bad.

Starting point is 00:16:24 For now, I want to say thanks again to my sponsors, nexus.com.com. Chainalysis and FTX. And thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace.

The Breakdown - Have We Passed Peak Inflation?

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