The Breakdown - Jerome Powell Says ‘More Work to Be Done’ as FOMC Hikes Rates 50 Basis Points

Episode Date: December 16, 2022

This episode is sponsored by Nexo.io, Circle, Kraken and the Galaxy Brains Podcast.   Today’s episode is a deep dive into the Federal Open Market Committee meeting. NLW covers not just the policy updates but the details of Chair Jerome Powell’s speech and the Q&A after. The big message coming from the Federal Reserve is “there’s more work to be done.”  - Nexo is a security-first platform where you can buy, exchange and borrow against your crypto. The company ensures the safety of your funds and keeps innovating with products like the Nexo Wallet - a non-custodial smart wallet that allows you to create your Web3 identity. Get early access at nexo.io/wallet. - Circle, the sole issuer of the trusted and reliable stablecoin USDC, is our sponsor for today’s show. USDC is a fast, cost-effective solution for global payments at internet speeds. Learn how businesses are taking advantage of these opportunities at Circle’s USDC Hub for Businesses. - Kraken, the secure, trusted digital asset exchange, is our sponsor for today's show. Kraken makes it easy to instantly buy 185+ cryptocurrencies with fast, flexible funding options. Your account is covered by regular Proof of Reserves audits, industry-leading security and award-winning Client Engagement, available 24/7. Sign up and trade today at kraken.com/breakdown. - Galaxy Brains: Whether it’s breaking down market volatility or analyzing the latest development, come for the latest market insights from our in-house trading professionals and renowned experts from across the industry. Stay for the occasional rap from host Alex Thorn. Check out the latest episodes here: https://www.galaxy.com/research/podcasts/galaxy-brains/?utm_source=BD&utm_medium=podcast&utm_id=CoinDesk - “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 "Glasgow" by Falls. Image credit: Alex Wong/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 nexo.io, Circle, and Cracken, and produced and distributed by CoinDesk. What's going on, guys? It is Thursday, December 15th, and today we are talking about FOMC Day. 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. I'm excited to also share that this week the podcast is brought to you by Galaxy and the Galaxy Brains podcast. Transparency is more important than ever in crypto. If you're here,

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Check it out at galaxy.com slash research. All right, friendos, well, today is day two of our macro theme, of a companion show to yesterday's inflation discussion. Now, to sum up that show, yesterday the whole point was that we got better than expected inflation numbers in both October and now for November. In October, inflation came down from 8.2% the month before to 7.7% headline inflation in October, and in November, we got 7.1% headline inflation for the month, which was below the 7.3% expected by economists. On top of that, month-over-month core inflation went up just 0.2% in November versus 0.3% in October and 0.6% each in August and September.

More importantly, in many ways, the declines in inflation were broad-based, meaning they weren't just limited to one category or another. The more broad-based the declines are, the more likely it is to represent a real trend versus just being a statistical anomaly. Or, as we discussed for October, a byproduct of how something is calculated, such as the annual shift in health insurance premiums that we experienced in October. Now, the fact that the inflation declines were broad-based, plus the fact that it had been two months in a row has had the effect of emboldening the doves on the FOMC, who believe that the Fed needs to slow down or even pause to better assess the impact of its rate raises so far.

However, most of the market assumed that the new inflation data was coming in just too close to the FOMC meeting that happened on Tuesday and Wednesday of this week to really influence the policy for this meeting. Instead, most people were interested to see if and how it would impact how Powell indicated the Fed was thinking about things going forward. Would he confirm growing openness to policy shifts, or would he retain a hawkish tone? Well, the policies themselves came in largely as expected. The Fed raised the policy interest rate by half a percentage point or 50 basis points to a range between 4.25 and 4.5%. Balance sheet reduction will continue as planned. Currently up to $60 billion

per month of treasuries and $35 billion per month of mortgage-backed securities are being allowed to roll off the Fed's balance sheet. But what about Powell's speech? TLDR, this was a more work-to-do speech. Powell says, we understand the hardship that high inflation is causing and that we are strongly committed to bringing inflation down to our 2% goal. Over the course of this year, we have taken forceful actions to tighten the stance of monetary policy. We've covered a lot of ground, and the full effects of our rapid tightening so far are yet to be felt. Even so, we have more work to do. We continue to anticipate that ongoing increases will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2%

over time. Restoring price stability will likely require maintaining a restrictive policy stance for some time. In light of the cumulative tightening of monetary policy and the lags with which monetary policy affects economic activity and inflation, the committee decided to raise interest rates by 50 basis points today, a step down from the 75 basis point pace seen at the previous four meetings. Of course, 50 basis points is still a historically large increase, and we still have some ways to go. So you're hearing in just this small sample some ways to go, more work to do. The other thing that's worth noting is that there is no concession around any sort of shift in what the long-term inflation goal should be. It is 2%, 2%, 2% to

reinforced numerous times throughout this speech. What about what the Fed thinks about the recent inflation numbers. Powell again says the inflation data received so far for October and November show a welcome reduction in the monthly pace of price increases, but it will take substantially more evidence to give confidence that inflation is on a sustained downward path. Participants continue to see risks to inflation as weighted to the upside, which is of course a fancy way of saying that people on the FOMC think that it's more likely that inflation surprises and goes up than inflation surprises and goes down more quickly. Powell says longer term inflation expectations appear to remain well anchored.

but that is not grounds for complacency. The longer the bout of high inflation continues, the greater the chance that expectations of higher inflation will become entrenched. Again, this is just another way of saying, more work to do, still have some ways to go. Now, when it comes to areas the Fed is concerned about, the labor market remains the boogeyman. Powell says job gains have been robust. Although job vacancies have moved below their highs and the pace of job gains has slowed from earlier in the year, the labor market continues to be out of balance,

with demand substantially exceeding supply of available workers. Now, when it comes to how they hope to address it, they're not looking towards a recession but to quote-unquote moderating demand. Powell says we are taking forceful steps to moderate demand, so it comes into better alignment with supply. Our overarching focus is using our tools to bring inflation back down to our 2% goal and to keep longer-term inflation expectations well anchored. The word forceful comes up a number of times in the speech,

which I'm not ready to say means anything yet, but is something to keep an eye on. Now, when it comes to future projections, the FOMC is projecting PCE inflation of 5.6% by the end of this year, falling to 3.1% in 2023, 2.5% in 2024, and 2.1% in 2025. That means effectively that the Fed is not forecasting getting to 2% until 2026. This is another example of them pouring cold water on the abandoning the 2% target rhetoric. Now, when it comes to the federal funds rate, they think 5.1% by the end of 2023, 4.1% by the of 2024, 3.1% by the end of 2025, which is still above the estimate of longer run levels.

Reporting is assuming that 5.1% at the end of 2023 is a close approximation of the Fed's terminal rate. And the point of these projections is to tell us that the higher for longer idea is viewed to be at least out to the end of 2025. However, as you might expect, the farther out into the future you get, the less consensus there is among Fed officials. In an ecosystem where innovation is the norm, it's the basics that are in the spotlight. Nexo is a company that has never put the safety of clients' funds in question. With over 50 global licenses, $775 million in insurance, and a real-time audit of custodial assets, Nexo sets an example for security standards in the industry. Apart from keeping their 5 million

clients safe, Nexo has kept building. They've just announced their non-custodial smart wallet. Visit nexo.io. That's nexo.io and sign up today. This episode is brought to you by Circle, the sole issuer of USDC and a leader in crypto that's held to a higher standard. USDC is a fast, safe, and efficient way to send money around the globe. USDC is always redeemable one-to-one for U.S. dollars and has over $45 billion in circulation as of October 13, 2022. Plus, Circle posts weekly reserve reports and monthly attestations of reserve capital, letting users know that USDA is safe, transparent, and compliant with regulations.

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No matter how you like to trade, Cracken Pro is built to make it happen. it pro.cracken.com or download the CrackenPro app on Google Play or the Apple App Store today. Now moving on to the Q&A section. Someone asked, will further hikes be in 25 basis point increments? When will you stop? Powell says, now that we're coming to the end of this year, we've raised 425 basis points this year and we're into restrictive territory. It's now not so important how fast we go. It's far more important to think what is the ultimate level, and then at a certain point the question will become how long do we remain restrictive. That will become, the most important question. I've told you today we have an assessment that we're not at a

restrictive enough stance even with today's move. The strong view on the committee is that we'll need to stay there until we're really confident that inflation's coming down in a sustained way and we think that will be some time. Again, Powell here is saying more work to do, some ways to go. In the Q&A, Powell also broke down how he sees the three buckets of inflation, saying with goods inflation, housing services inflation, and non-housing-related core services. On goods inflation, Powell said that supply conditions are getting better, demand has settled down a bit, and went back to services. On housing services inflation, quote, very, very high and will continue to go up as rents expire and have to be renewed. He believes that component will come down sometime next year. Now, when it comes to

non-housing-related core services, he said, quote, there's an imbalance in the labor market between supply and demand. That part of it, which is the biggest part, is likely to take a substantial period to get down. I think one way to interpret this is that they feel that they have goods under control. They've given up on shelter providing any meaningful signal but are satisfied that it's coming down, but it's all about labor market strength now. Now, of course, people ask about recession. Someone pointed out that the GDP projection is at 0.5% at stall speed, and the unemployment projection is now up a full percentage point, which is typically in range for recession. However, Powell says, I don't think it would qualify as a recession because you've got positive

growth. We've got growth at a modest level, about half a percentage point. That's positive growth. It's slow growth. It's well below trend. It's not going to feel like a boom. It's going to feel like very slow growth. Many analysts believe that the natural rate of employment is actually elevated at this moment. It's not clear that those forecasts are very much above the natural rate of employment. That 4.7% is still a strong labor market. The reports we get from the field is that companies are very reluctant to lay people off. Generally, companies want to hold on to the workers that they have because it's been very hard to hire. You've got all these vacancies out there far in excess of the number of employed people. That doesn't sound like a labor market where a lot of

people will need to be put out of work. Still, Powell says, I wish there are a completely painless way to restore price stability. There isn't. Now, what about the test for when cuts happen? Powell says, quote, I wouldn't see us considering rate cuts until the committee is confident that inflation is moving down to 2% in a sustained way. That's the test I would articulate. And finally, one little interesting note is around China reopening. Someone asked whether China reopening is disinflationary due to supply chains easing or inflationary due to commodity demand. Powell thinks, quote, those two things will offset each other. Weaker output in China will likely push down commodity prices, but it could interfere with supply chains ultimately and that could push inflation

up in the West. It doesn't seem likely that the overall net effect would be material on us. China faces a very challenging situation and reopening. We've seen waves of COVID around the world can interfere with economic activity. China is a very critical place for manufacturing and exporting. their supply chain is very important. China faces a reopening. There could be very significant increases in COVID. It's a risky situation. So to try to give kind of a summary of this, I think the key bullet points are these. Higher for longer. We've got a ways to go. The Fed is not thinking about recession or downside possibilities. The Fed is also not worried about short-term market loosening and is sticking to longer-term persistence. The Fed believes that they are just now getting to restrictive rate levels and need

to go higher still. The Fed believes that inflation coming down is promising, but they're very worried about sticky non-shelter services inflation, i.e. the inflation that comes in the labor market. The Fed is very clearly, at this point, not changing the 2% long-term inflation target. They're not even thinking about changing it. Please stop asking. And of course, they're still focused on the lessons of the past. Powell said the historical record cautioned strongly against prematurely loosening policy. We will stay the course until the job is done. Now, all of this feels a little on autopilot. It feels like the Fed has made their play, and now they just need to wait and see what the economy does next. In that context, one of their battles is how to rain

in, as we heard on yesterday's show, the quote-unquote animal spirits of the market. David Rosenberg, the president at Rosenberg, research tweeted, why doesn't Jay Powell save us all the time and just say, we don't want the stock market to go up and call it a day? And I think what he's referring to is that although this was a kind of banal FMC meeting and presser, Powell and the Fed clearly chose to slant hawkish, likely in order to try to tamp down on any potential market rally, which would make their work harder. This has been the fight all year long between the Fed and the markets, with the Fed saying one thing and the market saying we don't believe you, which is, in and of itself, a shift away from the whole don't fight the Fed mentality that arose over the last

decade. It's not just commentary that reflects this, the market sort of did as well. There really wasn't a big market response one way or another. The S&P 500 closed down 0.6%. reinforcing this perception of the Fed being like shrug, yep, it is what it is. Former New York Fed President Bill Dudley said, quote, it's going to take a while for the Fed to achieve what they want to achieve. They have to slow the economy down sufficiently to generate enough slack in the labor market, so wage trends come down to be consistent with 2% inflation. Michael Continopoulos, the director of fixed income at Richard Birdstein advisors, said,

quote, this is a market that is cherry picking what it wants to hear. Powell basically said, buyer beware, we're hiking more than was generally anticipated. We're going to stay there for longer than you think. And if you want to buy risk knowing that, that's fine, but do so at your own peril. Pointing out that shift in how the market might be thinking about the Fed, Samir Samana, the senior global market strategist at Wells Fargo said, another possible read, though, could be that the Fed has to go higher and stay there longer because of market-based easing of financial conditions.

It just seems like markets, after saying for years to not fight the Fed, have decided that it's now okay, and I just can't see that ending well. Alan Levinson, the CIO at Overlay Capital Partners, writes, bonds are basically unchanged. market clearly doesn't listen to Powell. I will bet green money we don't see the terminal rate Powell is espousing. Lisa Abramowitz, a host at Bloomberg, said the Fed, we're hawkish. We have more work to do. The market says, got it, so you're going to do another step down to a 25 basis point rate hike in February, and then we'll be cutting rates later in the year. Got it. And stocks are now up on the day. Now, we obviously know that that didn't stick, but it still is a pretty good representation of how the market just might not be listening to Powell in the same way that it used to.

Later, Lisa Abramowitz again tweeted, The Fed projects a 5.1% Fed funds rate at the end of next year, much higher than what the market expected. Stocks fall, but the market moves aren't as big as I'd think. Fed funds futures are still pricing in cuts by the end of next year with a peak rate around 4.8%. So that's how the market is thinking about this, didn't move much of one way or another,

and everyone is just focused on zooming out to where things land ultimately. Now, speaking of the future of the Fed, one note going into 2023 is that the FOMC will rotate for the next next meeting at the start of February. Fed presidents Loretta Mester of Cleveland, Susan Collins, of Boston, James Bullard of St. Louis and Esther George of Kansas City will all lose their vote in 2023, with presidents Patrick Harker of Philadelphia, Neil Kashkari of Minneapolis, and newly appointed presidents Austin D. Gulesby of Chicago and Lori Logan of Dallas gaining a vote on next year's committee. I've seen a couple people say this is three hawks out, three doves in, but I don't

necessarily think that that's exactly true. Bullard and Mester are definitely hawks. Collins and Georgia are a little more neutral. In coming, Keshkari has been swinging lately more hawkish this year but historically doveish. And also, it's a little too early to call on fresh appointees, as some people change a lot once they're in the hot seat. The biggest change might just be that Bullard has less power in voice. He seems to have been the spokesperson for the Hawks for much of this year and appears to be part of Powell's power center. That alone might be enough to collapse some Hawk power. But who knows. Anyways, guys, that was FOMC Day. Hope this was useful. Hopefully it gave you a better sense of where that macro is even as crypto continues to not particularly

care too much about the macro day to day. I'm sure there'll be more to talk about in the weeks and months to come on this front, but for now, I want to say thanks again to my sponsors, nexus.com. Circle, Cracken, and Galaxy Brains podcast, and thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace.