The Breakdown - Markets Are Betting On a 100bps Rate Hike This Month

Starting point is 00:00:04 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 Saturday, July 16th, and that means it's time for the weekly recap. A quick note, before we dive into the weekly recap, though, there are two ways to listen to the Breakdown podcast. You can find us on the Coin Desk podcast network that features not only the breakdown but other great Coin desk shows and which comes out every afternoon, or you can listen on the Breakdown Only feed, which comes out a few hours later. Wherever you listen, if you're

Starting point is 00:00:47 enjoying the show, I would so appreciate a rating or a review. It makes a huge difference. Also, a quick disclosure. In addition to them being a sponsor, I also work with FTX. And lastly, this week, I am thrilled to have Avalabs as an additional sponsor. Did you know that you can bridge Bitcoin natively across the Avalanche bridge and take advantage of the growing DeFi ecosystem on Avalanche? This is just one of the innovative features of CORE, the new non-custodial browser extension and wallet developed by Avalabs. Core is engineered for Avalanche users to have the most secure and seamless Web3 experience. Easily swap assets, display your NFTs in style, and store your assets in a ledger-enabled wallet. Plus, you can put real dollars in your

Starting point is 00:01:28 core wallet in just a few clicks. Go to core. app to access the full power. of Web 3 on Avalanche. So this week, instead of just a deep dive on some topic I haven't had a chance to do yet, we are doing a true weekly recap, looking at the most important stories from the days before. And we're going to start with the biggest macro event shaping, well, everything in markets right now, which was the June inflation numbers which we got on Wednesday. Now, if you go back to last month when in the beginning of June we got May's numbers, they kind of took people by surprise. Economists had by and large, expected, inflation to go down slightly, to still be high at, you know, 8%, 7.9%, but instead we surprised

Starting point is 00:02:10 the other direction, hitting 8.6 on the CPI. In the wake of this surprise markets, but especially crypto, were absolutely hammered. We're talking ETH and Bitcoin being both down 30 to 40%, and other assets going down even more. Remember, June ended up being the worst month in Bitcoin's history when it comes to price. Now, when those numbers came in, the Fed was widely. anticipated to be heading towards a 50 basis point rate hike in June and a 50 basis point rate hike in July. However, at the last minute, the Fed started signaling through their preferred channels that they might go up to 75 basis points, 0.75% increase in the federal funds rate, and that was indeed what they did. The 0.75% increase was the biggest increase since 1994,

Starting point is 00:02:59 and all of that together meant that this month's CPI reports was extremely. extremely highly watched. Starting from Monday, the White House was prepping and damage controlling and narrative shifting. Effectively, they were saying expect a really high number, but also, just so you know, it doesn't reflect that gas had already been coming down continuously. The argument which they've continued with throughout this week is that the extremes of the number that actually came through was largely backward looking and didn't anymore reflect the reality, particularly when it comes to the price of gasoline. The number that came in way, for the year-over-year CPI growth was 9.1%. This was the biggest jump since 1981. In addition,

Starting point is 00:03:40 the CPI had grown 1.3% month over month. Gasoline, food, and shelter were all big drivers of this increase. Now, this certainly reinforced the consensus view that the Fed was going to at least stick with their 75 basis point plan. But over the next 36 hours or so, it also increased how much of the market thinks that we're headed to something even more dramatic. By Thursday, the bond market was pricing in more than an 80% probability of a 100 basis point, aka a 1% rate hike at the FOMC meeting at the end of July. Keep in mind a week ago, there was effectively 0% probability of that showing up in markets, and only a 7.6% probability by Tuesday night ahead of the CPI print. Charlie Bielo pointed out that the last time the Fed hiked rates by 100 basis points in a single

Starting point is 00:04:27 meeting was 1981. The same time inflation was last above 9% in the U.S. When a Fed governor was asked about the possibility of a 100 basis point rate hike in July, he responded, everything is in play. To which Alex Kruger tweeted, guess 100 basis points in July then. Now, on top of just this most immediate meeting coming up, expectations of what we're likely to see at the September and November meetings are starting to change as well. Whereas previously, the market had thought that the fall would see smaller hikes of back to 25 basis points or something like that, those expectations have been revised up significantly. The market is now betting on a 75 basis point hike in September and a 50 basis point hike in November. And good Lord, the politics around

Starting point is 00:05:12 inflation is just brutal for Biden and the Dems. Bloomberg on Thursday wrote Biden calls inflation numbers out of date. Americans disagree. And goes on to say, quote, Fed officials took it differently. Federal Reserve Bank of Cleveland President Loretta Mester said that she had, quote, not seen any convincing evidence that inflation had turned the corner, and Fed board member Christopher Waller called the Consumer Price Index report, quote, a major league disappointment. So will the Fed back off? Frankly, it seems unlikely. They are fully on the Jerome Powell is Paul Volker, not Arthur Burns' tip. Outspoken investor Bill Ackman wrote a long threat about this as well. Quote, implicitly, the markets expect a more aggressive Fed will push us into recession by year end and then cut rates in response. Fed dot plots from a few weeks ago suggest that the federal funds rate will rise to slightly higher levels, remain flat in 2023, with a gradual reduction beginning in 24. After today's move, the disparity between the forward federal funds curve and the Fed has widened

Starting point is 00:06:07 further. The market appears to assume that the Fed will act as it did in the last three recessions by immediately easing when the economy goes into recession. While this seems intuitive, the lessons of the stagnationary periods of the 70s and 80s suggest a different policy response. Today's economic backdrop with high nominal demand, limited supply, and high inflation is much more comparable to the 70s and 80s experience than that of the last three recessions that are top of mind for investors. Arthur Burns' legacy is tarnished by his decision to lower rates as real GDP slowed during a period of high inflation. This catalyzed years of massive inflation which was not quelled until Volker took the federal funds rate to 20%. Burns' policy error is well

Starting point is 00:06:47 understood by Powell and the Fed governors and likely explains their dot-plot curves. We believe the Fed will keep the federal funds rate at higher levels for longer, even if we enter a recession in 2023 or sooner. And we believe demand will remain elevated, supply will remain constrained, and high levels of inflation will persist. The Fed has two blunt tools, the federal funds rate and managing expectations. Year-end federal funds projections are beginning to approach where they need to be. Market expectations for federal funds needs to be managed upward beginning at year-end and for the next 18 to 24 months. Markets remain dismissive of dot plots and recent statements by Fed governors on the risk of allowing inflation expectations to become unanchored. I expect the market will adjust federal

Starting point is 00:07:26 funds expectations upward as the Fed provides more clarity and emphasis on the need for higher rates for longer, and when market participants carefully review the 70s and early 80s precedents and their comparability to current economic conditions. The reason it's worth reading this whole thing is, one, it actually gets at the nut of what I think the Fed is thinking about, which is this comparison to the 70s. And two, because in many ways, people like Bill Ackman saying this out loud, gives them effective cloud cover from Wall Street to continue on this path. In times like these, security of your assets should be your number one priority. If you want to offset risk as much as possible and still stay in crypto, you need a trusted

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Starting point is 00:09:23 both Ethereum and Solana NFTs. When you trade NFTs on FTX, you pay no gas fees. Download the FTX app today and use referral code breakdown to support the show. So that is the macro, but back into the crypto world, it was another spicy week of leverage unwind. At the beginning of the week, it was all three arrows capital taking the headlines. 3AC creditors had claimed that they were not cooperating, that the whereabouts of the founders weren't known, and that they feared assets were being disposed of. They asked for an emergency hearing which was scheduled for Tuesday and which ultimately granted the creditors' request for a subpoena to 3AC to produce a list of assets at controls.

Starting point is 00:10:03 But then the drama just kept going. Suu popped back up on Tuesday to accuse the creditors of baiting them. He also accused them of malfeasance and acting in bad faith for not exercising warrants around Starkware, which could have been valuable and contributed to the assets 3AC had in reserve to payback creditors. Now, the community was fairly mixed on this accusation. Many agreed in principle that if the liquidators explicitly and intentionally didn't exercise the warrants, it would represent bad faith. But also were sympathetic to the fact that the entanglements of this firm

Starting point is 00:10:32 are likely so labyrinthian that they might not have known what was going on, something made all the more difficult by Sue and Kyle's whereabouts not being known. So yeah, big drama. Celsius, meanwhile, spent the beginning of the week paying back smart contract loans to access their collateral before finally filing for Chapter 11 bankruptcy protection on Wednesday. In both cases, then it's clear that the crypto contagion has moved into a distinctly legal phase, where a lot of people's assets are going to be subject to a court process that is not at all likely to move fast. Which actually brings us to another story that we haven't had a chance to discuss, which is Mount Gox. Somehow, some way, so many years later, we are getting a little bit of Mount Gox fud

Starting point is 00:11:12 for ourselves, despite the fact that the majority of the people in this space now hadn't even heard of crypto back when this was all happening. The reason for that is that last week, the trustee carrying out the Mount Gox rehabilitation plan, asked Gauks former users to register on an online claim filing system. This led people to believe that the trustee is now preparing to actually make repayments based on a plan that had been approved by creditors last year. This should be good, right, after eight years people getting their Bitcoin back? Well, the concern is that all of these forced long-term holders will dump all at once, crashing the price of Bitcoin.

Starting point is 00:11:44 George Calutis from CoinDesk isn't buying it. In a piece aptly titled, no, Mount Gox payouts aren't going to torpedo Bitcoin's price, he writes, Mount Cox wasn't able to get the stolen Bitcoin, so the trustee is not actually paying $850,000 BTC to creditors. Mount Cox only holds around 141,6,846 Bitcoin Cash, or BCH, and $69,776,2,441 yen. So instead of a one-time $850,000 Bitcoin liquidation, a worst-case scenario would look like this. 100% of creditors opt for the trustee to liquidate, and the trustee, ST opts to do that all in one fell swoop and sell 141,000 Bitcoin. That represents 8.8% of the total daily exchange volume. Surely that's meaningful, but it wouldn't be the first time 141,000

Starting point is 00:12:32 Bitcoin was sold in a day. George also pointed out CoinDest conversations with numerous forced holders who had become convinced by the time without their Bitcoin and the change in the price that if anything, they wanted to get the potential cash part of the settlement sooner so they could buy more Bitcoin at these depressed prices. Still, it is kind of crazy that there may be some coming resolution on something that was such a huge part of the crypto story in its early days. Now on to a part of the story that is still very much unresolved crypto regulation. One of the pieces that kept getting bumped this week in the breakdown was the Fed's Lael Brainer giving a speech about crypto, Defi specifically, a week ago Friday at a Bank of England

Starting point is 00:13:08 event. Paul Krugman loved it, and that's probably all you need to know about what it said about crypto. He writes, reading Laelbrainer's call for crypto regulation. For a document necessarily written in Fed speak, it's remarkably scorching. It's right there at the top. Brainerd in effect suggests that in addition to the dot-comish hype, crypto has the worst elements of shadow banking, quote-unquote innovation that's less about doing something productive than about evading prudential regulation. The thing is, this free-for-all of hype and scams briefly created a $3 trillion asset class. Where were the regulators? I suspect that when the full story comes out, it's going to involve not just ignorance but a fair amount of corruption. Brainerd is probably right in saying that crypto hasn't

Starting point is 00:13:48 gotten big enough or leveraged enough to pose major systemic risks. But a lot of people have been financially ruined thanks to the failure to rein this thing in earlier. Always, always love seeing Paul's commentary on our industry. Just warms the heart. Anyway, Miller Whitehouse Levine, the policy director of the DeFi Education Fund basically saw this as the quote-unquote defy regulation speech. He summed up that Brainerd had comments on defy risks including counterparty concentration, existing regulatory frameworks applying to defy and centralized finance alike, but presenting challenges and cascading liquidations. It has always felt to me that Defi was going to be in the hot seat at some point from a regulatory standpoint, and I think that that point is coming

Starting point is 00:14:29 sooner rather than later. Lastly, ending today's show on a note about big picture power shifts. Last weekend, there were a ton of tweets and stories around bank protests in China. I'm always fairly nervous about China-based stories where I don't really know the details. So many folks have incentives to tell the story one way or another from the C-E-Strecht. PCP that has so much media control to people trying to use it as a totem in American political discourse. But it still seems fairly significant. On Sunday, Chinese authorities violently dispersed a protest consisting of hundreds of depositors demanding the return of their savings from banks in the Hannan province.

Starting point is 00:15:04 Since April, four rural banks in the region have frozen millions of dollars worth of deposits from hundreds of thousands of customers. The protest took place outside of the Xunjo branch of the Chinese Central Bank, the People's Bank of China. It's the largest protests in China since the pandemic. and one anonymous protesters said, I did not expect them to be so violent and shameless this time. There was no communication, no warning before they brutally dispersed us.

Starting point is 00:15:26 Why would government employees beat us up? Were only ordinary people asking for our deposits back, we did nothing wrong. On Sunday night, the Hanan banking regulator issued a brief statement that the relative departments were speeding up efforts to verify information on customer funds at the four rural banks and are, quote, coming up with a plan to deal with the issue. Local police also said that they arrested members of an alleged, quote, criminal gang and tried to associate it with this. Jennifer Zeng, a Chinese independent journalist, said this is huge, don't know how this will end.

Starting point is 00:15:54 Hanan Bank is not the only one that is having problems with liquidity. All four Chinese banks are having the same issue. Some depositors found that they can save and cannot withdraw money with their bank cards. Alex Gladstein writes wild threat of videos of depositors in Hanan, who have protested for months to get their money back after banks froze withdrawals in April. They face down armed police and get brutalized but continue to organize. Protecting one's savings is a powerful incentive to protest. test. I think there is likely a lot more to the story here, and it's something that I'm

Starting point is 00:16:21 definitely keeping my eyes on, but it's hard to ignore entirely, given how significant it would be if the Chinese bank really is having trouble around liquidity for these depositors. So, as you can probably tell, there is a lot going on, even though we're supposed to be in the quiet summer periods, but it's never a dull week if you're hanging around the right place. For now, I want to say thanks again to my sponsors, nexus.com. I know. Chianalysis, Ft, and Ava Labs, and thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace.

The Breakdown - Markets Are Betting On a 100bps Rate Hike This Month

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