The Breakdown - Investors Are Betting on Inflation Declining. Are They Right?

Episode Date: September 13, 2022

This episode is sponsored by Nexo.io, Chainalysis and FTX US.   Bitcoin was up 15% over the weekend. Stocks have seen four days of green. The reason? Investors are anticipating that August’s inflation numbers (to be released on Tuesday) will show another monthly reduction in the inflation rate, suggesting that we’re past peak inflation. Will they be proven right?  - Nexo is a security-first platform where you can buy, exchange and borrow against your crypto. The company ensures the safety of your funds by employing five key fundamentals including real-time auditing and recently increased $775 million insurance on custodial assets. Learn more at nexo.io. - Chainalysis is the blockchain data platform. We provide data, software, services and research to government agencies, exchanges, financial institutions and insurance and cybersecurity companies. Our data powers investigation, compliance and market intelligence software that has been used to solve some of the world’s most high-profile criminal cases. For more information, visit www.chainalysis.com. - FTX US is the safe, regulated way to buy Bitcoin, ETH, SOL and other digital assets. Trade crypto with up to 85% lower fees than top competitors and trade ETH and SOL NFTs with no gas fees and subsidized gas on withdrawals. Sign up at FTX.US today. - I.D.E.A.S. 2022 by CoinDesk facilitates capital flow and market growth by connecting the digital economy with traditional finance through the presenter’s mainstage, capital allocation meeting rooms and sponsor expo floor. Use code BREAKDOWN20 for 20% off the General Pass. Learn more and register at coindesk.com/ideas. - “The Breakdown” is written, produced by and features Nathaniel Whittemore aka NLW, with editing by Rob Mitchell and research by Scott Hill. Jared Schwartz is our executive producer and our theme music is “Countdown” by Neon Beach. Music behind our sponsors today is “Razor Red” by Sam Barsh and “The Life We Had” by Moments. Image credit: Francesco Carta fotografo/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 sponsored by nexus.com, and FTCS, and produced and distributed by CoinDesk. What's going on, guys? It is Monday, September 12th, and today we're talking about why traders are betting on inflation declining. Are they right? 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. Also, a disclosure as always. In addition to them being a sponsor of

the show, I also work with FTX. All right, we are setting up for an interesting week. And so today, what we're going to do is look at a few of the stories that set the tone for what we're likely to see throughout. Specifically, we are going to be honing in on the macro, but before we get into that, you might have noticed that crypto has been having a bit of a run of it. Bitcoin was up about 15% over the weekend in a rally that started on Friday. Other cryptos followed as well, although they've been cooling slightly in the last couple of hours. The same was true with stocks. Last week, each of the three major U.S. stock indices closed up more than 2%. Monday continued that trend. This morning, some of the indices were up as much as around 1%, and all of the S&P 500's 11 sectors

were rising. If the trend continues, this will be the S&P's fourth consecutive day of gains. So what is going on? Well, in Bitcoin, there were a lot of explanations proffered. Noticeably, there was a pomp capitulation argument saying that Anthony Pompliano had removed his laser eyes and taken the word Bitcoin out of his Twitter profile, allowing the next cycle to begin. Alex Kruger listed that plus the macro factors we'll get into, but suggested that as related to Bitcoin specifically, he thought it might be the market front-running the news, which happened after the stock market close on Friday, that an SEC filing showed that micro strategy was considering selling $500 million in stock to purchase more Bitcoin. However, by and large, most people are looking to

the macro, and specifically to inflation expectations, as the causal factor for these gains. Tomorrow at 8.30 in the morning on the East Coast, we get U.S. inflation data for August. It's the last and most important piece of data ahead of the FOMC meeting next week. At that meeting, the Fed will decide whether to raise rates and by how much. As that meeting and tomorrow's data approaches, expectations are that inflation will head down again. I've seen emerging consensus start to suggest that economists are looking to see inflation having fallen to 8% or 8.1% in August. after hitting a peak of 9.1% in June and falling to 8.5% last month in July.

Month over month, Joe Wisenthall from Bloomberg says that consensus estimates are a 0.1% monthly decline in core CPI. You'll remember last month we had the whole friccacy dust up around whether we should be looking at month over month or year-over-year numbers, which is, of course, part and parcel of how political inflation is in the lead up to the U.S. midterm elections. Now, what are the signals pointing to decreased inflation? One is commodity prices coming down. Last week, oil futures fell to their lowest prices since the middle of January, which was

more than a month before Russia's invasion of Ukraine. Overall, oil prices are down 34% since the post-invasion peak in March. And that's despite OPEC cutting production. Other prices that appear to have gone down based on private sector tracking include airfare, used cars, hotels, and even rent increases are starting to show some signs of easing as well. The Co-Star Group, which is a private data gatherer, suggested that average apartment rents were up 9.4% in Q2 2022 year over year. Now, that might seem high, but it's down for more than 11% annual increases during the previous

two quarters. On top of that, quarter two is typically the strongest rental market period, adding even more heft to that relative decrease. Paul Krugman thinks that this is significant. He tweets, Apartment rents peaking? More important than people may realize for economic policy, because rents, market rents and imputed rents on owner-occupied housing, are key drivers of all measures of core inflation. Inflation less food and energy is 40% shelter. Median inflation, basically its owner's equivalent rent. These measures respond with a lag to rental rates on new apartments. But if rents flattening

indicates core inflation, which drives Fed policy on course to flattened two. Now, if this story is positive, if inflation does appear to be coming down in certain key categories like rents also appear to be coming down, might that affect what the Fed does next? Well, expectations are still fairly firmly primed for a 75 basis point increase, which would be the third 75 basis point increase in a row. Last Friday, Nick Timorouse of the Wall Street Journal published a new piece called Fed officials back another large rate increase. Nick is pretty much seen by the market as a channel for the Fed to prime them on what's coming next. So this sort of piece, just a few days before the inflation data, and a week and a half before FOMC, is seen as a strong

signal. Now, of course, the debate hasn't really been whether to stop raising rates or not, but whether to do another full 75 basis point hike, which is what we got over the summer, or to walk that back slightly to a 50 basis point increase instead. Nick pointed to a speech by Fed Governor Christopher Waller on Friday where Waller said, looking ahead to our next meeting, I suppose, support another significant increase in the policy rate. Such an increase is necessary to get the policy rate to a setting that is clearly restricting demand. Based on all the data we have received since the Fed's last meeting, I believe the policy decision at our next meeting will be straightforward. So although Waller isn't using a specific number, he's clearly intimating a 75 basis point hike.

Another Fed official Cleveland Fed President Loretta Mester also did an interview on Friday, where she said that the federal funds rate needed to get to 4% faster than she anticipated. quote, we're going to need to move a bit faster than I thought to get to that rate, given the persistence we have in inflation. Right now, the federal funds rate is 2.25 to 2.5%, so still about a point and a half to hit that 4% target. Those comments also came from an interview on Friday. Now, in these interviews, the Fed officials are also arguing that current inflation data isn't likely to impact their decision all that much. Waller, in fact, argued that a short-term deceleration in inflation last year led to a delay in their withdrawal of stimulus,

which was a big error in retrospect, so they're not going to do that this time. Quote, The consequences of being fooled by a temporary softening in inflation could be even greater now if another misjudgment damages the Fed's credibility. So until I see a meaningful and persistent moderation of the rise in core prices, I will support taking significant further steps to tighten monetary policy. It also appears that these officials are starting to consider geopolitical risk in a more significant way. Here's a quote from a Wall Street journal piece.

While many forecasters now expect the CPI to show that overall inflation declined last month due to falling fuel prices, Ms. Mester said that she was putting less weight on any decline in energy prices because she is concerned prices could turn up again later this year amid a standoff between Russia and Europe. Instead, she said she wanted to see signs that service sector price pressures, which could more broadly reflect rising wages, were moderating. Quote, I would welcome a good report on inflation, but I don't think that one report is going to change my view that were really just at a high inflation level, and the risks are that it stays high. Now, to the extent we're wondering if the Fed is going to get back to forward guidance, in other words, letting markets know where they specifically expect the federal funds rate to be in future periods.

I would read pretty much all recent signals as a big no on that. Waller said that everything is too up in the air to really give any confident expectations about where interest rates are going to need to be. Instead, he's sort of offering scenarios, saying that if inflation moderates as expected, then maybe they get to 4% and then see how it goes. If inflation accelerates, they keep going beyond that 4%. And if there is some radical drop-off, maybe they go less than 4%, but that's the least likely scenario. Also on Friday, and by the way, you can see that they really have folks out right now talking about this and setting the market's

expectations, Kansas City Fed President Esther George echoed these concerns about getting too specific around future rate predictions. Quote, as unsatisfying as it might be, weighing in on the peak policy rate is likely just speculation at this point. notably George was a dissenting opinion on the 75 basis point hike in July, instead recommending a half percentage point increase, with her argument being that there are inevitably delays between lifting rates and the increased borrowing costs that come from that and which are the actual vehicle for slowing economic activity. Nexto is a security first platform built for the long run with everything you need for your

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Download the FTCX app today and use referral code breakdown to support the show. Now, one thing the Fed will be watching closely is consumer expectations. You heard in Waller's statement an echo of what we've heard from Fed Chair Powell over. and over, which is about the risk of losing people's confidence by taking the foot off the break too soon. The Federal Reserve is absolutely terrified of inflation expectations becoming entrenched, because that can create serious self-fulfilling prophecy. If people expect things to be much more expensive in the future, they buy more now, which creates more demand, which increases prices, which creates the inflation they expected in the first place. It also increases the likelihood

of them pushing for wage increases, which could help set off the dreaded wage price spiral. Now, when it comes to these expectations, a report from the Federal Reserve of New York came out today that shows some progress. The bank released their August survey of consumer expectations, which showed that one year from today, households expect inflation to be at 5.7%. In July, they expected that year-out inflation to be 6.2%. Zooming even farther, three years out, in July, people expected to see 3.2% inflation, and now they see 2.8% inflation. five years from now they see inflation at 2% down from July's 2.3% forecast. Now, while this is just one data point, it is very likely to be quite calming for the Fed. One of the big things in this report was also specific changes in expectations around home prices.

The expected level of home price increases, zooming out one year, fell from 3.5% in July to 2.1% last month. That marks the lowest reading since July 2020. The bank also said that this decline in home price rise expectations, quote, was broad based across demographic groups and geographic regions. And they also added that, quote, home price expectations have now fallen by nearly two thirds since the April 2020 reading of 6%. And actually I want to dig into this a little bit more. Obviously, we've been following the housing story because it's one of those big shifts that actually so many people are a participant in in some way. anecdotally, I've been observing something interesting that I've seen reflected in what others are seeing as well.

Coming into the pandemic, we had just a confluence of factors which were affecting home prices. For one, we had a decade worth of underbuilding coming off of the great financial crisis in 2008, 2009, which led to a mismatch between inventory and demand already before COVID-19 hit. That, of course, led to increased home prices. When the pandemic did hit, we obviously got this extreme exogenous shock, which led to a massive, surge in demand. I mean, this was a generational event of people fleeing cities and totally changing expectations around work and life and so much more. And what's more, when it comes to the housing market, it wasn't just like a bunch of new demand showed up. You had a secondary

restriction on supply because the people who were considering selling their homes were like, yeah, no. That's either because they couldn't hold open houses, something practical like that, or because they weren't sure they were going to be able to find another house because there was such crazy demand, so they stayed put. Therefore, you had a generational shortage from a previous crisis, hit a new crisis which caused elevated demand and more reduced supply. And so, of course, prices went absolutely crazy. Now, prices remained high. We heard that just in April 2022, people expected house prices to go up another 6% by next year. But since then, talk of recession has started to hit. The Fed has started to crank rates. All of these stories of people now being

priced out of the market because of increased financing costs are coming to media. And perhaps as a reaction to that, you've seen way more inventory come online. A lot of it, anecdotally at least, is people who wanted to sell a couple years ago trying to sneak in their sales while prices are still elevated. But then, all the buyers who are watching Zillow like crazy people are saying, hey, so much more inventory is coming online, I wonder if something is shifting. Maybe I'll hold my horses for a minute. And then we have this total psychological reversal, where all of a sudden, power is moving back from the sellers to the buyers. Meanwhile, some of those sellers who listed get nervous and lose conviction that they can actually sustain the high prices of last year, so they

reduce their prices, which the same buyers again see, which confirms that things are shifting back in their direction, which further reduces their incentive to jump quickly, which keeps this whole shift and power back to the demand side increasing. That's what I've been noticing personally, and it seems like that's starting to bear out in the numbers as well. Fannie Mae's monthly sentiment survey for August showed that consumers expected house prices to fall over the next 12 months for the first time since 2020. For the first time since the housing market started running hot, more markets are seeing negative price movements than positive. 80% of markets saw either negative or flat movement in July. Goldman Sachs are forecasting that the U.S. housing market

downturn will continue to worsen in 2023, and private equity giant Blackstone has announced that they will halt single-family home purchases in 38 regional markets by the end of September. Rents appear to be a part of this as well. According to a report from Apartments.com, national rents are also showing signs of a big decrease. Year over year, rent increases decline to 7.1% in August, down from 8.4% in July. Only 13 of the 40 largest markets saw month-over-month rent increases or stability. Jay Libick of Kostar Group said, quote, after a 20-month run of positive monthly growth dating back to December 2020, the market finally witnessed negative asking rent growth on a monthly sequential basis from July to August, with rents down 0.1% in July. We're seeing a complete

reversal of market conditions in just 12 months, going from demand significantly outstripping available units to now new deliveries outpacing lackluster demand. The Kobayse letter, in typical dramatic fashion, writes housing market update. One, supply of new homes in U.S. at highest since 2009. Two, median home price down 6% in two months. Three, over five million houses not current in mortgage payments. Four, mortgage demand now lowest since 2000. Five new home sales down 50% in two years. macro alphrates for the first time in 18 months, U.S. homes are selling on average below their asking price. The Fed wants the housing market to cool down, and they'll get it to cool down. Meanwhile, autos are seeing something similar.

New vehicle inventory has hit its highest level since June of last year. According to Mannheim used car index, wholesale used car prices declined by 4% in August, which was the largest decline in the data going back to 2008, excluding the April 2020 drop. So what all of this brings up is a question. Is this inflation transitioning? Is this the tightening actually making its way through the economy? Is this the market resetting post-COVID? Or does it represent something more severe?

Some strong disinflationary impulse rippling through the economy? I don't think anyone knows yet, but it shows just how strange the moment we're living through is, where signals can be pointing in very different directions all at once. I've called what we're experiencing right now the great repricing, and I thought that Jeff Lewis from Bedrock Capital nailed it in this. quote, from houses to startups, we're at a moment in time where nobody knows what anything should be priced at. So that's the context for the inflation data that we get tomorrow morning. And of course, as you know, I'll be here to break it down for you when it comes.

For now, I want to say thanks again to my sponsors, nexus.com.com. And thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace. I want to tell you about CoinDesk's new event. The investing in digital enterprises and asset summit or I, The event facilitates capital flow and market growth by connecting the digital economy with traditional finance. Join CoinDesk October 18th and 19th in New York City for a 360-degree investment experience, where you can source, invest, and secure the next big deal in digital assets.

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