The Breakdown - Inflation Surprise! Markets Swerve Wildly as Core CPI Rises at Fastest Pace Since 1982

Starting point is 00:00:00 Honestly, if you go read Bloomberg or Wall Street Journal's analysis of why stocks came roaring back, it is so clear that no one has any idea. And this ultimately is perhaps the perfect demonstration of markets right now. It's one big Foxmolder desk sign that says, I want to believe, despite the fact that there's just no evidence that the Fed is going to let up any time soon. Welcome back to The Breakdown with me, NLW. It's a daily podcast. podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by nexo.io, circle, and FtX, and produced and distributed by CoinDesk. What's going on, guys? It is Thursday, October 13th, and today is inflation day. Before we get into what is just a wild and weird,

Starting point is 00:00:51 strange moment in markets, 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. Also a disclosure as always. In addition to them being a sponsor of the show, I also work with FTX. All right, folks, well, remember when just a couple of months ago there was a big dust-up because President Biden decided to focus on the zero percent month-over-month inflation

Starting point is 00:01:20 number that had come in to claim that inflation was at zero? And remember how, even though lots of people poked fun at that clear politicking, markets were more than happy to pile on to the narrative that inflation had peaked and so the Fed would be forced to pivot. And remember how then the Fed said that they thought there would be more pain ahead and we did this three or four times? Well, that was the setup heading into today's release of the official September inflation numbers. Estimates for headline year-over-year inflation were super concentrated at 8.1%. Almost all the big bank guesses had that number, with Credit Suisse coming in at 8% and TD Securities on the other side at 8.2%. In terms of month-over-month increase in core CPI, which is the number that the Fed cares more about,

Starting point is 00:02:01 consensus predictions had us at 0.4%. Now, a couple important things to remember about this particular inflation print. The first is that it will have a big impact on the Fed's thinking about November's rate hike. The second is that it is the last inflation print before midterm elections in November. So that's the setup. Now, going into today, a lot of the discussion was around Fed minutes that were just released from the last FOMC meeting, and the growing debate therein between concern about doing too little and inflation expectations becoming entrenched, and concern about doing too much and launching the U.S. economy into a worse-than-necessary

Starting point is 00:02:35 recession. The minutes for the September FOMC meeting were released on Wednesday and showed the beginnings of concern over sustained interest rate hikes. From the meeting notes, quote, several participants noted that, particularly in the current highly uncertain global economic and financial environment, it would be important to calibrate the pace of further policy tightening, with the aim of mitigating the risk of significant adverse effects on the economic outlook. Going on, quote, several participants observed that as policy moved into restrictive territory, risks would become more two-sided,

Starting point is 00:03:06 reflecting the emergence of the downside risk that the cumulative restraint and aggregate demand would exceed what was required to bring inflation back to 2%. To put that in layman's terms, they were concerned that they might overshoot. Going on, quote, they agreed that by moving its policy purposefully towards an appropriately restrictive stance, the committee would help ensure that elevated inflation

Starting point is 00:03:25 did not become entrenched, and that inflation expectations did not become unanchored. Finally, the money line. Many participants emphasized that the cost of taking too little action to bring down inflation likely outweighed the cost of taking too much action. But if there is any big takeaway from these minutes, it's that that is the debate that's now being had at the Fed level. The minutes showed a growing concern about how long supply chain constraints have taken to ease and continued tightness in the labor markets has puzzled officials who are looking for some reduction in job vacancies by now. Within the context of the growing debate around whether the Fed is hiking too much too fast, Vice-Chail Lail Braynard apparently led the debate that the Fed should

Starting point is 00:04:03 temper rate hikes to mitigate the risk to the economy. The argument here is basically that the Fed needs to allow enough time for tight monetary policy to make its way through the economy. But clearly that concern right now and that perspective remains in the minority relative to people who are just concerned about higher inflation. Anna Wong, the chief economist at Bloomberg, said, quote, The Minutes Show policymakers are worried about downside risks to growth, but are even more worried about upside risks to inflation. Still optimistic projections for the labor market suggest the committee may be underestimating the blow to employment from tighter monetary policy. So again, the TLDR is really just that they're starting to look at the downside risk to growth

Starting point is 00:04:41 seriously. We're starting to see them ask questions about policy lag. But then again, that comes up against PR concerns and the desire to be seen as doing something right through to when inflation fully breaks. They've also set themselves some narrative traps. Powell is now fully committed to this Volker-not-Burned strategy, and that means they'll be unlikely to accept a pause in any of this hiking until some significant data is in front of him that gives him cloud cover to do so. Fed comments on Wednesday kept beating the same drum. Federal Reserve Governor Michelle Bauman reinforced the idea of needing further large rate hikes. In a speech given at NYU on Wednesday, said, if we do not see signs that inflation is moving down, my view continues to be that sizable

Starting point is 00:05:21 increases in the target range for the federal funds rate should remain on the table. It is not yet clear, she said, how high we will need to raise the federal funds rate and how much time will pass before we begin to see inflation moving back down in a consistent and lasting way. Baumann also said that forward guidance was of minimal use right now compared to its previous efficacy. High uncertainty, she said, puts a premium on flexibility. She drew attention to the fact that explicit forward guidance in 2021 had actually, hindered the Fed's ability to react to inflation in a timely manner.

Starting point is 00:05:50 Quote, the facts on the ground were changing quickly and significantly, but the communication of our policy stance was not keeping pace, which meant that our policy stance was not keeping pace. In separate comments at a town hall in Wisconsin on Wednesday, Minneapolis Fed President Neil Kashkari said that the bar for a Fed pivot is, quote, very high. Quote, if the economy entered a steep downturn, we could always stop what we're doing. We could always if we needed to reverse what we're doing. if we thought that inflation was headed back down very, very quickly.

Starting point is 00:06:17 For me, the bar for such a change is very high, because we have not yet seen much evidence that the underlying inflation, the services inflation, the wage inflation, the labor market, that is not yet softening. Want to keep more profits when trading? Get the best possible prices and trade with 50% lower fees on NXO Pro. The new Spot and Futures trading platform uses aggregated liquidity of over 3,000 order books collected from multiple sources.

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Starting point is 00:07:21 FDXUS 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 FtX app today and use referral code breakdown to support the show. Fed speakers in recent weeks have been adamant that no pivot is coming, trying to avoid a repeat of August, where markets rallied following some moderation in inflation, anticipating a more imminent pivot. Keshkari said, quote, I think we're quite a ways away from anything like that. I think a much more likely scenario is we will raise to some level north of 4%, maybe 4.5, and then pause and sit there for an extended period of time while the tightening we've already

Starting point is 00:07:59 done works its way through the economy. When asked why the Fed was not considering even more aggressive hikes arriving at their destination more promptly, Keshkari said, if we just went up 2% or 3% or 4% in one shot, it may well be that that's too much and that we end up overdoing it needlessly. So by moving and looking at the data and seeing how the economy is responding, It allows us to try to measure the dosage somewhat while still moving aggressively. So that's where we were going into September CPI numbers this morning. So what happened?

Starting point is 00:08:26 Utter carnage. Headline inflation was 8.2% year over year, slightly above estimates. Overall core inflation was up 6.6% and month over month, CPI came in at 0.6%. Both surprises to the upside and the fastest rate of core inflation growth in 40 years since 1982. Bloomberg's Joe Wisenthal had jokingly written, remember, as soon as the number lands, start stripping out various categories to find the number most favorable for your narrative.

Starting point is 00:08:53 But honestly, there was basically nothing good in there to try to spin. Shelter, food, medical care all went up. Shelter, which makes up one-third of the overall CPI index, rose 0.7% for the second month in a row. Rent and owner's equivalent rent were up 6.7% annually, which is the most on record. What's more, even minus, shelter, services rose at a record annual pace. Trader Alex Krueger tweeted, Core CPI came in as bad as it gets, and markets agreed. Thomas Thornton from Hedge Fund Telemetry wrote, Fun fact or not, the S&P 500 is on track to open lower by more than 1% after six consecutive losses and at a 52-week low.

Starting point is 00:09:30 Since the inception of the futures market in 1982, only one other day matches this level of carnage, October 10, 2008. At the open, the S&P 500 was down 2.15%, the Dow was down 1.75%, and NASDAQ was down 2.8%. percent. Muhammad El-Eryan wrote quite a reaction to the inflation data. The big move down in equity futures and spike in yields adds to concerns about negative economic spillovers. Then there are the liquidity and orderly market functioning issues. To think, some of us have been told we have been too hard on the Fed. Jim Bianco tweeted the early 2020 pre-pandemic peak in the S&P 500 was 3,393. As I write, the S&P 500 points away from erasing the entire post-pandemic bull market. The Wall Street Journal summed up the mood with their headline, the CPI report was everything investors were fearing.

Starting point is 00:10:19 Now, on the flip side, treasuries ran in the other direction. The 10-year treasury yield went above 4% for the first time since 2011. Now, there is also another dimension of this inflation, in the U.S. at least, which is the political dimension, and boy, was this print brutal for the Democrats. Even with all the spin in the world, this report really gave them very, very little to work with. The White House released a half-hearted statement about how some progress was being made, but there was more work to be done, but then promptly shifted to saying it would be worse with the other guys. In a statement, President Biden said, because of my economic plan, the United States is in a stronger position than any major economy to take on this challenge. Republicans, he claimed,

Starting point is 00:10:57 would seek to repeal the Inflation Reduction Act, which would be, quote, the exact wrong thing to do in this moment. If Republicans take control of Congress, everyday costs will go up, not down. So far, that message has not seemed to resonate with American voters, but we'll see if it does in the days and weeks to come. Speaking of the days and weeks to come, what What can we expect going forward? Well, markets are starting to price in the potential for a surprise jumbo hike. From 0% odds going into today, odds of a 100 basis point rate hike in November had jumped up to 17%. This type of jumbo hike was also in the chatter as well. Andrew Brenner, the head of international fixed income at Nat Alliance Security, said horrible CPI number. Will they go to

Starting point is 00:11:36 100 basis? Seema Shah, the chief global strategist at Principal Asset Management said, there can't be anyone left in the market who believes the Fed can raise rates by anything less than 75 bips at the November meeting. In fact, if this kind of upside surprise is repeated next month, we could be facing a fifth consecutive 0.75% hike in December, with policy rates blowing through the Fed's peak rate forecast before this year is over. The composition of the inflation reading is perhaps even more worrisome than the overall number. Increases in shelter and medical care indices, the stickiest segment of the CPI basket, confirm that price pressures are extremely stubborn and will not go down without a Fed fight.

Starting point is 00:12:11 Ian Lingen, the head of U.S. rate strategy at BMO Capital Markets, said, while there is sure to be chatter on the potential for a 100 basis point hike, this print cements 75 basis points in November, with the more relevant question whether December and February's hikes will now be upsized. The Wall Street Journal's Nick Timrose, aka the Fed Whisperer, repeated this line. His piece today, inflation reports seal case for another 0.75 Fed rate rise in November. Now, some are striking an even scarier tone, suggesting that we might also see headlines inflation go back up as well. Steve Chiavarone, the senior portfolio manager at Federated Hermes, said,

Starting point is 00:12:44 this report raises the risk that we may see a new cycle high in headline inflation before the end of the year. With energy prices moving back up, a mid-90s oil price in December could see us surpass the 9.1% headline peak from June. Looking at the components, what is most worrying is the big jump in services. Service inflation is the most sticky. This is where both shelter prices and wages reign supreme. Macro Alf writes, when U.S. core inflation is at 40-year highs, the Fed care zero about the rest of the world. One, will it end up breaking something? Most likely yes. Two, will it stop them? Yes, if the repo or treasury markets freeze. Maybe if we see some big insolvency. Not there yet. Now, at that point, it's also worth noting that there's the

Starting point is 00:13:24 beginning of chatter from some officials on some concerns around markets breaking. Bloomberg yesterday ran a piece Yellen worries over loss of adequate liquidity in treasuries. Answering questions following a speech in Washington, Treasury Secretary Janet Yellen said, quote, we were worried about a loss of adequate liquidity in the market. Bloomberg writes, The balance sheet capacity of broker dealers to engage in Treasury's market making hasn't expanded much, while the overall supply of Treasuries has climbed. Yelan noted that the Federal Reserve now has a standing repurchase facility to provide a liquidity backstop to the Treasury's market that can be helpful. She also said that the so-called group of 30 panel has presented some good

Starting point is 00:13:58 ideas on reforms that would help strengthen the market. Anyways, details aside, there has been, within this week, a shift in the tone and language around some of these questions around market function issues. Another thing that you're starting to see a lot more of on FinTwit is the comparisons to 2008. Eric Basmagi in tweets, is this 2008 again? Of course it's different. However, this is becoming less and less dissimilar in the sense the Fed will be very late to ease policy and address a very severe downturn in the housing market. By the time they do, it will be too late. So with all of this, is there anything that Wall Street is watching for? Well, increasingly, it looks like St. Louis Fed President James Bullard has become the go-to guy for hints of a Fed pivot among Wall Street analysts.

Starting point is 00:14:40 While this year, Bullard has been a cheerleader for Fed Hawks, he's maybe better conceptualized as just an unconventional thinker. Simon Mukuda, the chief economist at State Street Global Advisors in Boston said, quote, he's very non-consensus. Concepts he has introduced, novel concepts have ultimately become more mainstream. In 2021, while Chairman Powell was pushing the narrative of transitory inflation, Bullard represented the lone voice out of the Fed warning of the need to get moving with rate hikes. From March, Bullard consistently advocated for jumbo hikes, dissenting on the decision to only move rates by 25 bips. Bullard's ideological flexibility has led him to be ahead of the curve in recent years and now positions him as a bellwether for Fed sentiment. David Blanchflower, a former Bank of England

Starting point is 00:15:19 policymaker who's now a professor at Dartmouth College, voiced concern over the lack of a dovish contrarian on the current FOMC. Bullard, he says, quote, at least has been prepared to give a different view, which is good, and the least subject to group think. Bullard's views of the causes of inflation were shaped by the 1970s, but not of the 1970s. While the consensus opinion at the time was that trade unions and government spending were the cause of inflation, Bullard has formed his own ideas on the cure. Quote, it has to come through the businesses themselves, the price setters in the economy. They have to have the fear of God in them that if they raise their prices too much, they're going to lose market share. So what is Bullard saying right now? Honestly, nothing good

Starting point is 00:15:57 for Bulls looking to a Fed pivot. It's a little premature, he says, to say when we can declare victory. The near and medium-term goal is getting moving in the right direction. Now, just as the perfect Danu Ma to this episode, I wrote it this morning before a doctor's appointment with my son and came back a couple hours later, and by the time I came back, the stock market had roared back in one of the weirdest days of trading I've seen. Jim Bianco says Fin Twit explaining the rally as the Fed is going to pivot. In parentheses, it's all they have. This news has not reached the bond market, which he says is now putting the probability of a

Starting point is 00:16:29 75 basis point hike on November 2nd to 100%, and the probability of a fifth consecutive 75 basis point hike in December at two-thirds or 66%. Honestly, if you go read Bloomberg or Wall Street Journal's analysis of why stocks came roaring back, it is so clear that no one has any idea. And this ultimately is perhaps the perfect demonstration of markets right now. It's one big foxmoulder desk sign that says, I want to believe, despite the fact that there's just no evidence that the Fed is going to let up any time soon. For now, I want to say thanks again to my sponsors, nexus.com, and FTCS, and thanks to you guys for listening.

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The Breakdown - Inflation Surprise! Markets Swerve Wildly as Core CPI Rises at Fastest Pace Since 1982

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