The Breakdown - Inflation Drops Most In 2 Years, but Not Everyone Is Buying It

Starting point is 00:00:00 In the wake of one of the most tumultuous years in crypto history, the conversations happening at Consensus 2020 have never been more timely and important. This April, CoinDess is bringing together all sides of the crypto, blockchain, and Web3 community to find solutions to crypto's thornyest challenges and finally deliver on the technology's transformative potential. Join developers, investors, founders, brands, policymakers, and more in Austin, Texas, April 26 to 28th for Consensus 2020. Listeners of The Breakdown can take 15% off registration with code Breakdown. Register now at ConsenSys.com and join CoinDesk at Consensus 2023.

Starting point is 00:00:43 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 CoinDest. What's going on, guys? It is Wednesday, April 12th, and today we are talking about about the latest inflation print. But before we dive in, a quick reminder, the breakdown is expanding to become the breakdown network. We've launched a new show, Bitcoin Builders, which you can find anywhere you listen to podcasts. And most importantly, if you're listening to this show on the CoinDesk Podcast Network feed, you'll need to switch over to the breakdown-only feed. After April

Starting point is 00:01:23 23rd, the breakdown will only be available on that breakdown-only feed. For more on the announcement, go listen to the show that I put out yesterday, April 11th, called Announcing the Breakdown network and Bitcoin builders. All right, with that out of the way, today we are doing a big sweeping macro overview focused on CPI. This really is what gets the FinTwit folks out of bed, I have to say. Now, expectations coming into today's release of CPI inflation data kind of predicted more of the same. Forecasts were firmly in line with recent trends, expecting a 0.4% monthly increase in the core CPI, which of course strips out food and energy. That would be exactly in line with the six-month average. This would bring core CPI to

Starting point is 00:02:02 5.6% on an annualized basis. Core CPI clocked in at 5.5% for the prior month, meaning that we could be beginning to see a re-acceleration in the core inflation metric, which the Fed pays most attention to. The consensus prediction for headline CPI from Bloomberg and other surveys was around 5.2%. That would be the lowest level in nearly two years, but obviously still far exceeding the Fed's 2% inflation target. February CPI report showed a 6% annualized rate for headline inflation, so a significant drop from that would be welcome. A lower headline inflation, mark for March would also represent the ninth straight month of easing inflation. Now, while the effects won't be present in today's figures, which reflect inflation conditions for March, there are

Starting point is 00:02:42 concerns that inflation may re-accelerate after the announcement of surprised cuts to oil production earlier this month from OPEC. Oil prices remain stuck above $80 per barrel since that announcement was made, which is a price level not seen since November of last year. With the U.S. coming into summer's peak oil demand season, this increase in oil price could bleed into prices throughout the economy, instigating another leg up for inflation. March retail sales are projected to show a continued fall for goods demand, which has been a major disinflationary force in recent inflation reports. Bloomberg economists, led by Anna Wong, said in their analysis, quote, The March CPI report will offer glimmers of good news on disinflation. Plunging natural gas prices

Starting point is 00:03:21 in California, aided by a state government credit, helped. But the good news is likely transitory. Oil prices are rising again after OPEC plus announced production cuts. If that results in persistently rising gasoline prices, it could offset any disinflation gains in the next few months." End quote. Now, the Fed has been particularly watchful of non-shelter services inflation in recent months. This has remained sticky high on the back of tight labor markets. The most recent non-farm payroll report showed some significant softening of the labor market, but response to the report was mixed.

Starting point is 00:03:52 It absolutely showed progress in rebalancing the labor market, but that progress is slow and may not quite be enough to satisfy the Fed that its tightening of policy is having the desire effect. If you've been listening to this show over the last 18 months since this tightening cycle began, you've heard over and over how the Fed thinks that the labor market is the biggest issue that they have to contend with. Persistent tightness in the labor market makes them scared of a wage price spiral, and it also makes them feel like they have more room to tighten even farther. Now, in terms of some other categories, city economists forecast that medical services could see a rebound from a soft February print and expect recreation and personal services to remain high. One major wrinkle this

Starting point is 00:04:31 could come from used car prices, which had been a significant portion of the softening in goods inflation. Wholesale vehicle prices have been on the rise since the start of the year and are now beginning to feed through to retail prices. Diane Swank, chief economist with KPMG, said, quote, you've got a little bit of a tailwind on goods inflation that was absent in recent months coming back. It further complicates things when the places you are betting on cooling are reflating even temporarily. It's unlikely to show up in this March data, but we are beginning to hear reports that the market for securitized auto loans is drying up as part of a larger credit contraction in the wake of problems in the banking system. Car dealership guy writes, this is big. Capital One is pulling

Starting point is 00:05:09 inventory lines of credit, aka floor plans on dealers. Basically means its dealers have 90 days to refinance their inventory. From a source, quote, Cap 1 is completely getting out of the inventory lending game. An account called Meta Prime responded, floor plan lending is when a bank gives an auto dealer a loan to buy cars and then use the cars as collateral. If Capital One is pulling out, it because they believe the cars are going to be worth less, the dealers won't be able to sell enough, or both. So zooming out, the securitized auto loan market takes consumer auto loans and packages them into tradable securities for financial institutions. With this market frozen, credit for both retail and wholesale across the auto sector could become an issue. This may perversely make

Starting point is 00:05:48 supply tighter as drivers retain their vehicles for longer, unable to finance an upgrade, pushing prices on used vehicles higher in the short term. Obviously, this is just one segment of the economy, but it shows some of the wonky byproducts of when this sort of rate hiking cycle comes into contact with the larger credit contraction. So where were markets heading into this print? Goldman Sachs partner John Flood warned that they were pretty jittery. His Tuesday note suggested that the S&P 500 could drop by 2% if headline inflation increased from February 6% mark. Now that, of course, would be a result that was wildly out of consensus. If headline inflation came in at expectations or below, Flood predicted a rise in stock prices. He wrote,

Starting point is 00:06:27 stock market wants a softer print, as a hot reading will add more confusion and uncertainty into the equation of what the Fed does from here. Another hike in May, but then aggressive cuts in Q4, this is what the Fed funds futures are pricing in ahead of tomorrow's print. Now, overall, recently, inflation print release days have been highly volatile for markets. Over the last year, the S&P 500 has moved an average of 1.9% on CPI Day, that's more than double its average volatility for inflation days in the previous year. Since January, the main index is up 7% on the back of expectations that the Fed's hiking cycle is imminently coming to an end. This year's price action has provided little in the way of solid buying opportunities, with the largest weekly

Starting point is 00:07:05 decline of 4.6% coming alongside the collapse of Silicon Valley Bank. 22V research said in a note, investors are waiting for a pullback and think macro data will provide it soon, a theme that has not played out year-to-date. Results from the firm's survey showed that around half of respondents expected core CPI to be in line or higher that consensus expectations of 5.6%. And only a quarter of respondents viewed. this outcome as risk on. The markets are in this very weird spot. They've been slowly grinding higher basically every week, with the only dips being around data that looks recessionary. Year-to-date returns are sitting at around 7.5%, which is pretty hot and has led a lot of analysts to talk about

Starting point is 00:07:42 the track record of a hot Q1, tending to lead to a hot year. Still many thought that coming into this inflation print, markets weren't really viewing it as a major factor in what happens next. Ted talks macro writes, today is USCPI Day, and for the first time in a long while, it feels like the market is discounting the significance of this event. Trader positioning leading into today is nowhere near as conservative or risk off, as we typically would observe. Still, zooming out and looking at that year-to-date return of 7.5%, this is the type of environment where, last year, we would have seen the Fed trot out a ton of speakers to say that

Starting point is 00:08:14 the market isn't appropriately pricing the difficulties and potential for pain that still lies ahead as we fight inflation. And that indeed has been something that we've seen this time around as well. Fed speakers have been out in force recently, warning market. not to get ahead of themselves on expectations that inflation will cool off quickly. Minneapolis Fed President Neil Kashgari told a town event at Montana State University on Tuesday that although the turmoil in the banking sector appears to have calmed, he has seen no signs that inflation will rapidly cool from here.

Starting point is 00:08:41 Indeed, he seemed preoccupied with the inflation fight, answering a student's question about job prospects by saying, quote, it could be that our monetary policy actions and the tightening of credit conditions because of this banking stress leads to an economic downturn. That might even lead to a recession. We need to get inflation down. If we were to fail to do that, then your job prospects would be really hard. When asked about a steeply inverted yield curve, implying significant Fed rate cuts to arrive sooner rather than later,

Starting point is 00:09:06 Keshkari said he interpreted this as a market expectation that inflation would fall quickly, giving the Fed room to cut rates. Keshkari said that he is not that optimistic, and believes that inflation will still be above 3% by the end of the year. Moving on to Philadelphia Fed President Patrick Harker, Harker said that he was disappointed by slow progress on inflation during a Tuesday speech and said the Fed should be ready to take further steps to bring it down if necessary. Quote, since the full impact of monetary policy actions can take as much as 18 months to work their way across

Starting point is 00:09:33 the economy, we will continue to look closely at the available data to determine what, if any, additional actions we may need to take. When asked about his view on the Fed's policy path moving forward, he reiterated the consensus opinion that the Fed should hold rates above 5% for an extended period and rejected any notion of moving the Fed's inflation target above 2%. Harker said, if we see inflation not budging, then I think we'll have to take more action. But at this point, I don't see why we would just continue to go up, up, up, and then go

Starting point is 00:09:58 whoops, and then go down, down very quickly. Let's sit there. Newly appointed Chicago Fed President Ostand Gouldsby, meanwhile, urged caution in moving forward with further rate hikes, given the recent bank collapses. At moments like this of financial stress, he said, the right monetary approach calls for prudence and patience. He noted that bank lending surveys showed banks were already tightening lending standards, stating that he would be placing additional weight on surveys and anecdotal data about borrowing conditions for the time being.

Starting point is 00:10:25 Goolsby said, quote, given how uncertainty abounds about where these financial headwinds are going, I think we need to be cautious. We should gather further data and be careful about raising rates too aggressively, until we see how much work the headwinds are doing for us in getting down inflation. Goalsby also said that he didn't see any contradiction between the Fed's inflation fight and the need to maintain a stable banking system. I don't believe we should stop prioritizing the fight against inflation, he said,

Starting point is 00:10:47 but we also have to recognize that this combination could hit some sectors or regions in a way that looks different than if monetary policy was acting on its own. When it comes to market commentators, most folks I'm seeing are taking a pretty complex, nuanced view. Bob Elliott, the CIO at Unlimited Funds, writes, inflation is too high and too sticky given the Fed's mandate, and in the short term, it looks like things are going in the wrong direction. Services stability at elevated levels has been a big component of the elevated inflation pressure. In order to reverse this dynamic, nominal wage growth will need to decline from current level.

Starting point is 00:11:17 It's been elevated at the same level for nine months now. The decline in oil prices has been an important disinflationary impulse in the second half of 22, which gave illusions of the inflation problem being over. But in recent months, that decline is stopped and reversed. Traded oil prices are back at six-month highs. An important source of durable goods inflation over the second half of 22 came from used car prices rolling over. That is also stopped and reversed.

Starting point is 00:11:39 Wholesale prices through 10 days ago have started to rise again, and that will translate soon. A lot of the disinflationary pressures from the SPR drawdown, and the improvement in supply chains is behind us, and we are now seeing in the timeliest numbers that disinflation is receding. At the same time, the underlying services pressure remains constant. If anything, there are inflationary pressures in the pipeline here that suggest that inflation will be rising in coming months, not falling on a short-term basis. Inflation is slow-moving, and as we have seen in Europe, even weak but not terrible growth can keep inflation going. It's easy to see how the Fed could get to a point of pausing, given what they have done and go to

Starting point is 00:12:11 wait-and-see mode. But with this inflation backdrop, it's hard to see them soon making the case, that they'll be clearly on their path to the 2% target. Macro-analyst and Arte Carlo Doss put it even more crisply. He writes, Let me simplify inflation for everyone and preempt all the shit takes we're likely to hear over the next few months. Services are almost three quarters of core inflation and they are responsible for almost all core CPI expansion.

Starting point is 00:12:33 Services are still running very hot. Services have notoriously lower rate sensitivity. Services will remain supported by consumer savings buffer for a good few months still. Basically, this argument is that everything else's noise besides this core services inflation data, which, by the way, seems to track with what the Fed has been saying. So when all was said and done, what actually happened, what numbers came in? Well, in short, CPI came in a little lower than expected. Month over month,

Starting point is 00:12:59 CPI was up 0.1% in March, down from 0.4% the month previously, and most importantly, beating economist forecasts of 0.2%. Headline CPI was 5.0%, which is down a full percentage point from 6.0% in February. That was better than economists predicted. Remember, economists had been expecting to see 5.2% year-over-year inflation. This was the single biggest month annualized drop we've seen since the beginning of the tightening cycle. Core CPI, which cuts out food and energy, was up 0.4% month over month, which was in line with expectations. Year-over-year CPI was also in line with expectations at 5.6%. Now, in terms of interpretation, there are a lot of different analyses. Bloomberg took a pretty middle-of-the-road tone. U.S. core inflation slows only a bit,

Starting point is 00:13:41 keeping Fed on track to hike. The lead of that piece reads, Key measure of U.S. inflation showed hints of moderating in March, but likely not enough to dissuade the Federal Reserve from raising interest rates again next month. The Wall Street Journal was a little more boisterous. U.S. inflation eases to 5%, lowest in nearly two years. Twitter skeptics were out in four saying it's not real. Pomp writes the headline CPI number is down over the last 12 months, but it is up over the last one, three, and six months. Don't be fooled by the base effect. Inflation has not been getting better. Other analysts were digging into the specifics to try to look ahead. Joe Consorti wrote,

Starting point is 00:14:14 The energy component of the CPI basket is in deflation for the first time since 2021. Energy CPI year-over-year is down 0.5%. Economic activity is deteriorating. I think this time around, Joe Wisenthal from Bloomberg really nailed it. In his market's newsletter today, he wrote, The economy is always confusing and ambiguous, but this seems like a particularly noisy time. There is no limit to the possible interpretations of the macro data right now.

Starting point is 00:14:39 He goes on to point out that last Friday's job report was, quote, kind of soft landing-ish. The pace of new job creation was solid. Unemployment ticked down to 3.5% from 3.6%. Wages showed more deceleration and the labor force participation rate ticked higher. That would check all the boxes that the Fed in theory would like to see. Growth, but some loosening at the same time. On the other hand, Joe points out that there's also clouds forming around commercial real estate and credit availability. He points to an NFIB small business optimism survey and a measure of loan availability that showed its largest one-month drop since 2003. Then, of course, he says there's countervailing trends as well. Housing continues to be resilient. And as Joe writes,

Starting point is 00:15:16 if housing is getting going, that's an odd setup to be falling into a recession. The way that he sums it up is this. So, you can tell any story you want. The labor market looks soft landing-ish, issues in credit and banking warn of possible recession. What we're seeing in housing and auto still looks like heat. And the good news is that almost certainly after today's CPI report, you'll still be able to choose your own theory about this economy just with data to suit your story. In other words, this is an economy whose narrative is up for grabs. We're still very clearly in a weird liminal period where a lot of different factors are pushing in a lot of directions. To me, that suggests that the Fed is going to default to the path of least resistance,

Starting point is 00:15:53 which is at least one more hike and then we'll see from there. But later today, we'll also get FOMC minutes and see if there's any indicators there that that might not be true. In either case, I hope that even as this economy stays incredibly confusing, this show helped you at least understand the different forces pushing and pulling in various parts of it. I appreciate you guys listening. As always, remember, April 23rd, last day to listen to the breakdown on the CoinDesk Podcast Network feed. Go check out Bitcoin Builders. Keep an eye out for the AI breakdown.

Starting point is 00:16:22 And until tomorrow, be safe and take care of each other. Peace.

The Breakdown - Inflation Drops Most In 2 Years, but Not Everyone Is Buying It

There aren't comments yet for this episode. Click on any sentence in the transcript to leave a comment.