The Breakdown - Jerome Powell Finally Believes He Might Actually Get His Soft Landing

Episode Date: February 3, 2023

On today’s episode, NLW breaks down the Federal Open Markets Committee rate hike decision, as well as Fed Chairman Jerome Powell’s comments on inflation, the labor force, the debt ceiling and loosening financial conditions. While many commentators have argued that Powell failed to be as hawkish as he wanted, NLW argues that Powell’s ultimate objective may have actually changed over the last few months.  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 - Join the most important conversation in crypto and Web3 at Consensus 2023, happening April 26-28 in Austin, Texas. Come and immerse yourself in all that Web3, crypto, blockchain and the metaverse have to offer. Use code BREAKDOWN to get 15% off your pass. Visit consensus.coindesk.com. - “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 sponsor today is “Foothill Blvd” by Sam Barsh. Image credit: Kevin Dietsch/Getty Images, modified by CoinDesk. Join the discussion at discord.gg/VrKRrfKCz8.

I don't know, man, Powell at this point has a pretty good beat on what it takes to send a message to investors. This is a guy who scrapped his entire plan Jackson whole speech and hit him hard with an eight-minute speech that turned markets off a rally back last summer. If Powell had wanted to tamp down on markets and really fight the narrative around these loosening financial conditions, I think he would have done so, or at least I think it's a mistake to assume that that was his goal and he somehow missed it. So what could possibly be the explanation then. 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 CoinDesk.

What's going on, guys? It is Thursday, February 2nd, and today we are talking about the first FOMC rate decision of the year, and whether Chairman Jerome Powell is finally, truly, convinced that he has a chance at a soft landing. 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. Welcome back, everyone. I mentioned earlier in the week that this week would be the first really consequential macro week of the year. The reason, of course, is that the Fed's

first FOMC meeting was slated for Tuesday and Wednesday. Now, heading into this meeting, the markets were highly convinced that the Federal Reserve was going to continue to decrease its pace of rate hikes by increasing the federal fund's target rate by 25 basis points. While this would mean that interest rates were still climbing, by and large the market was more interested in the trend lined than in the specifics. In fact, coming into this meeting, the really big question wasn't so much how much rates would be raised, although of course the Fed could have surprised with a larger than expected hike. Instead, it was about what other signals and communications would there be about how the Fed was thinking about the economy as a whole

after a few months of seemingly declining inflation, and more granularly for stocks, what Powell would say about loosening financial conditions over the past few months that led to January's rally. Specifically, markets were waiting to see if Powell would seek to stamp out the enthusiasm, or would he strike a different tone? So what did we get? As expected, the FOMC decided to increase their policy interest rate by 25 basis points, bringing the target range to 4.5 to 4.75%. This represents another step down in the speed of hikes, which had been moving at a blisteringly fast pace of 75 basis points per meeting across five consecutive meetings last year, before slowing down to 50 basis points at the previous FOMC meeting in December.

Chairman Powell said shifting to a slower pace will better allow the committee to assess the economy's progress towards our goals, as we determine the extent of future increases that will be required to attain a sufficiently restrictive stance. Alongside this, Chairman Powell confirmed that quantitative tightening policy would remain steady, rolling treasury bonds off the Fed's balance sheet as they mature. Now, when it came to that all-important question of what the tone would be, Powell's speech was definitely lacking in the sort of hawkish tone that some pundits were predicting. His prepared remarks remained pretty similar to December's speech with no additional flourishes. He hit the same major notes that we've heard before. The labor market remains too tight.

Although wage growth appears to be moderating, the labor force participation rate hasn't improved. Inflation remains far too high, but longer-term inflation expectations continue to be well-anchored. Reducing inflation will likely require a period of, quote, below-trend growth and some softening of labor market conditions. Now, when it comes to forward guidance on future rate policy, Chairman Powell again articulated the FOMC's view that ongoing rate hikes will likely be appropriate, reiterating that, quote, the historical record cautioned strongly against prematurely loosening policy. We will stay the course until the job is done. Overall, Chairman Powell gave the impression of a data-dependent Fed that is hopeful about recent data but knows they don't have the full picture yet.

So let's now dig a little deeper into the specific areas of discussion, and let's kick it off with the one that has loomed large for the last year, inflation. In the discussion, Powell clearly recognized the improving situation regarding inflation, saying, quote, the inflation data received over the past three months shows a welcome reduction in the monthly pace of increases. While recent developments are encouraging, we will need substantially more evidence to be confident that inflation is on a sustained downward path. Regarding recent data showing a looming risk of recession, Powell said, that disinflationary process that you now see underway is really at an early stage. He noted that much of the moderation

in inflation appears to be simply due to desirable effects like supply chains becoming more functional. Now, while overall headline inflation is clearly moderating, Powell continued to point to non-housing services inflation as evidence that there is still more work to do. quote, we have a sector that represents 56% of the core inflation index where we don't see disinflation yet. We don't see it. It's not happening yet. It's still running at 4% on a 6-and-12-month basis.

There's nothing happening there. Indeed, this stickiness of services inflation was the main reason Powell viewed the inflation fight is still ongoing. It would be very premature, he said, to declare victory or to think we've really got this. We see ourselves as having a lot of work left to do. Now, very reasonably, some people asked him then, well, how much information and what data will you need to see to be satisfied that inflation is in check? To that, Powell responded, I don't think there is going to be a light switch flipped. I think it's just an accumulation of

evidence. And when it comes to any sort of pivot, Powell said that the Fed's base case is a slow disinflationary period, where it will not be appropriate to cut rates until at least the end of the year. Next topic, what about labor markets? Concerns about tightness and the labor markets have been at the very forefront of Powell's communications about how the Fed thinks about where the economy is headed and how they might need to evolve their policies. Specifically, persistent tightness has given them the confidence to stay the course with their tightening cycle, and has also made them, I think, more convinced that there is still room for a soft landing that doesn't involve some sort of brutal recession. Yesterday morning, the job openings turnover survey or Jolt's data was released,

showing the ratio of job openings to unemployed workers had moved back to 1.9. Although this ratio has previously been used as key evidence of labor market tightness by Powell, yesterday he dismissively called the date of volatile. Instead, he continued to categorize the labor market as, quote, too tight, citing high levels of job creation and a high rate of quitting. He did acknowledge a slowdown in wage growth as an early sign of labor market loosening. Asked whether he agreed with Vice Chair Lail Braynard's recent comments that she doesn't see any evidence of a wage price spiral, Powell confirmed the vice chair's assessment, but added, once you see it, you have a serious problem. That's what we can't allow to happen. And then, let's talk about those loosening financial

conditions. This was, of course, one of the biggest narratives heading into this FOMC meeting. Longer-term Treasury bond rates, along with mortgage rates, have been falling since October, while U.S. equity markets have been on a continual march higher. Financial conditions indices now stand at comparable levels to when the Fed began their rate hikes back in March last year after one of the most rapid periods of loosening observed in the 40-year history of the measurement. When asked if these loosening financial conditions make the Fed's job harder, Chairman Powell said, quote, it is important that overall financial conditions continue to reflect the policy restraint that we're

putting in place in order to bring inflation down to 2%. I would say that our focus is not on short-term moves, but on sustained changes to broader financial conditions, and it is our judgment that we're not yet a sufficiently restrictive policy stance. He then added even more softness to these statements, though, by asserting that, quote, many things affect financial conditions, not just our policy. He said that the FOMC will take into account a multitude of factors in setting policy, not just financial conditions. I think this discussion. I think this discussion in many ways was the most significant of the entire day. This is a major shift in language from December when Fed officials describe the rapid loosening of financial conditions as unwarranted,

and even from the beginning of the month, when they talked about stock market exuberance as being a major threat to the implementation of Fed policy. We'll get to why I think this might be in just a minute. Now, perhaps to be expected, given the broader political climate, there were a number of debt ceiling questions. Much to the disappointment of some pundits, the topic of whether or not the Fed would accept the hypothetical trillion-dollar platinum coin as a deposit from the Treasury was not specifically engaged with. However, on the topic of the debt ceiling, Chairman Powell said, quote, there's only one way forward here, and that is for Congress to raise the debt ceiling, so the United States can pay all of its obligations when due. Any deviations from that path

would be highly risky. No one should assume that the Fed can protect the economy from the consequences of failing to act in a timely manner. Now, another interesting discussion was that someone brought up Nick Timrose's recent article on whether the Fed's models were broken. The Wall Street Journal's Nick Timmeros explored discussions among Fed staff in an article this week, suggesting that some of the longstanding economic models common in central banking were being questioned behind closed doors. One of those in particular was the relationship between labor market tightness and inflation. Steve Listman of CNBC put the question directly to Chairman Powell asking, I'm wondering if you've considered the idea that your understanding of the inflation dynamic may be wrong,

and it's possible to achieve inflation reduction without a surge in unemployment. In response, Powell spoke to the still elevated inflation, visible in the non-housing services sector and said, quote, you're not going to have a sustainable return to 2% inflation in that sector without a better balance in the labor market. I don't know what that will require in terms of increased unemployment. There are a number of dimensions through which the labor market can soften. He followed that up saying,

I still think there's a path to getting inflation back down to 2% without a really significant economic decline or a significant increase in unemployment. He then went on to explain that this period of inflation was unlike previous episodes, driven largely by constrained supply chains driving high goods inflation. No one really knows, he said. This is not like other business cycles in so many ways. This is not a standard business cycle where you can look at the last 10 times there was a global pandemic and we shut the economy down. It's unique. Certainty is just not appropriate here. Lastly, when it came to forward guidance, Powell was pretty evasive when questioned on how many

additional rate hikes we can expect. Instead, he simply referred to his previous comment that ongoing rate hikes would be appropriate, while also noting that, quote, we're going to be looking carefully at the incoming data between now and the March meeting and the May meeting. I don't feel a lot of certainty about where the terminal rate will be. When asked how he views the balance of risk between backing off earlier hiking too much, Powell said it's very difficult to manage the risk of doing too little, and finding out in 6 to 12 months that we were actually close but didn't get the job done. Still, he added, we have no incentive and no desire to over tighten.

Join CoinDesk's Consensus 20203, the most important conversation in crypto and Web 3. 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, founders, brand leaders, entrepreneurs, and more. Use code Breakdown to get 15% off your paths. Visit consensus.com or check the link in the show notes. So what was the market's reaction to this?

Well, the lack of overt hawkishness, especially when it was kind of anticipated, definitely spurred markets higher. The S&P 500 was pretty flat when the 0.25% hike was announced, but saw about a 2% pop while Chair Powell delivered his comments. It ended the day up 1% reaching a 5-month high. The NASDAQ outperformed with a 2% gain on the day while Bitcoin moved up by more than 3%, hitting 24,000 for the first time since August. Writes-in-Chief economist Lou Crandall said of Powell's speech, he wasn't objectively doveish, but he wasn't overly competitive in pushing that point, and that was enough for the market. Karim Boss said chief economist said three capital management said, he almost kind of gave a green light to what's been taking place.

Now, a lot of the comments that I saw were something along the lines of this tweet from Kathy Jones, the chief fixed income strategist at Charles Schwab. Seems like Powell flubbed this one, meant to send a cautious, hawkish message, but ended up doing the opposite. Macro Alf said something similar. Today, he writes, we got very important news. Markets don't believe Powell at all. Powell's main job today was to push back against easier financial conditions. He didn't nearly push back

enough, and so markets are now rallying hard in his face. The thing is, this won't stop unless data comes in very hot, OMG, the Fed will turn hawkish again, or data comes in recessionary like, ohmg, this is not a soft landing. In the meantime, the window for the misplaced soft landing narrative is now extended. Picture this. The first innings of a recession always look like a soft landing, as growth and inflation come down, but not to alarming levels yet, exactly like today. And as markets myopically embrace, this soft landing narrative, Powell's lack of pushback against easier financial conditions adds fuel to the fire. Taking a deeper look at what Powell actually said, one big message becomes increasingly clear. Markets don't believe him. Now, I'm not commenting on whether Alph is right or wrong about the

idea that a soft landing is not possible and that this looks just like the early stages of a recession. But I do think it's interesting his assertion that Powell's main job today was to push back against easier financial conditions. This echoes Kathy Jones' assumption that she knows. what Powell was trying to do as well, meant to send a cautious, hawkish message. I don't know, man, Powell at this point has a pretty good beat on what it takes to send a message to investors. This is a guy who scrapped his entire plan Jackson Hole speech and hit him hard with an eight-minute speech that turned markets off a rally back last summer. If Powell had wanted to tamp down on markets and really fight the narrative around these loosening financial conditions,

I think he would have done so, or at least I think it's a mistake to assume that that was his goal, and he somehow missed it. So what could possibly be the explanation then? Here's the take of just one podcaster. I think Powell has always conceptually wanted a soft landing. He certainly talked about it lots. But I'm not totally sure he actually thought it was possible. What he's always been sure about is that he didn't want to be Arthur Burns, the Fed Chair who took his foot off the break too soon and let inflation run all over the 1970s. Indeed, if the choice was Burns or Volker, it was Volker all the way. I think that for a lot of last year, Powell thought that they were going to have to drive a recession to get demand down enough that it would combat supply chain issues. I think Powell has always believed that the causes

of this inflation weren't something that he had done, and so weren't something that he could control, and so that he had to come at the problem with the brute force of demand destruction, which was the only tool in his arsenal. So yes, the soft landing last year for him was a nice narrative, but it might have just been that, a narrative, because you're not allowed to say we got to cause a recession to get this thing done. However, what Powell is flirting with now is the idea that inflation really might be coming down, and labor markets might really be weakening but not totally faltering. And the stock market for all their bitching is fine, and so maybe, just maybe, that soft landing is actually on the table in a way that he didn't think was possible last year.

And if that's the case, if his soft landing spidey sense is tingling, then this might be exactly the sort of tow-the-line speech that he wanted to deliver to keep nudging towards that possibility. Could be wrong, but to me, that's the most rational read of this, as opposed to he just screwed it up. The end of the day, only time will tell, but we will certainly be here to watch when it does. I appreciate you guys listening as always, and until tomorrow, be safe and take care of each other. Peace.