The Breakdown - Markets Plummet as Inflation Comes In Hot

Starting point is 00:00:00 Indeed, one of the ironies is that the market's recent rally makes the Fed more likely rather than less likely to continue their hawkishness. The Fed deals in psychology and really needs to convince markets it's willing to do what it takes for however long it takes for prices to come down. 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.io, chain aliasis, and FtX. and produced and distributed by CoinDes. What's going on, guys? It is Tuesday, September 13th, and today we are talking about inflation coming in hot

Starting point is 00:00:41 and what it means for the economy. Before we get into that, however, if you are enjoying the breakdown, please go subscribe to the show, 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. Also a disclosure, as always, in addition to them being a sponsor of the show, also work with FTX. All right, folks, well, as we discussed yesterday, today was going to be a big day one way or another. It was inflation print day, meaning we were going to get numbers from the Bureau

Starting point is 00:01:14 of Labor Statistics about August's inflation. This is the most anticipated data point in markets right now, because it's really the report card on how things are changing. While markets had already priced in another 75 basis point hike for this coming FOMC meeting next. week, the inflation print really wasn't about whether or not that was going to happen, but instead the anticipation was whether we'd see a continuation of the trend that we saw last month, which was, of course, inflation going down, or at least leveling off. If we saw something similar, it would be confirmation of the inflation has peaked narrative, which would mean that even if there was perhaps a few months of lag, the Fed could at some point start to itself

Starting point is 00:01:56 peak the aggressiveness of monetary tightening as well, which would of course mean that assets could take less of a beating. This is what investors have been anticipating for the last four days. We've seen green, green, green, green in anticipation of a good inflation report. Estimates coming in in aggregate were that we'd see 8% year-over-year headline inflation, with Credit Suisse and Morgan Stanley guessing on the low side of 7.9% and Bank of America and HSBC on the other end with 8.2%. If anything, the Twitterati, we're talking about the possibility of a welcome surprise to the downside. Michael Harris, the founder at Price Act, Action Lab, writes, CPI excluding what you need and pay for will be down big time tomorrow.

Starting point is 00:02:36 Mayhem for markets, writes, even if CPI comes in softer than expected, I believe the Fed will hike by 75 basis points next week. They don't focus on this data set, but more that they want to slow the economy further, and to do that, they want to tighten financial conditions that have been loosening of late. Cameron Dawson and the CIO at New Edge wealth writes, the watch item for CPI tomorrow is if we see month-over-month declines and CPI spread to other items outside of energy. Consensus has headline at negative 0.1% thanks to lower energy prices, and core still plus 0.3% thanks to sticky factors like rent and services, while goods prices could be softening. Month over month, economists expect a slight decline of headline inflation

Starting point is 00:03:14 to fall 0.1%. Now, this month-over-month versus year-over-year thing is actually more relevant than it might seem. Last month, when July's inflation numbers came in, the year-over-year number was 8.5%, but the monthly number was zero percent inflation growth between June and July. This gave the Dems, led by President Biden, leave to talk about how inflation was at zero percent. Of course, this left out some key contextual details about how persistently high annual inflation remained and triggered just about every Republican and right commentator, but this is part and parcel of the pre-midterm process whereby everything becomes radically partisan. Joe Wisenthal from Bloomberg was one of the folks who defended the month-over-month discourse.

Starting point is 00:03:54 He tweeted this morning, remember folks, year-over-year inflation numbers are for politics, Twitter, not us. He actually expanded this in the Bloomberg Markets newsletter as well, writing, here's why, obviously, we should be talking about the month-over-month numbers after the data comes out today. The trillion-dollar question in the economy is whether inflation is slowing down. Comparing August 22 to August 21 doesn't help you answer that question at all. That's just too long of a time frame to tell us anything useful about what's happening in the economy right now. Last month was wearing that one measure of inflation showed cooling while the other one was hot.

Starting point is 00:04:24 This is unusual. But again, only one of these measures actually tells you something new or interesting about the trend now, and that's the sequential number. So that's obviously the crucial one to look at. And all that being said, what really is going to matter probably is the sequential core number, since we know that gasoline prices are plunging a lot. What's actually going to matter for the Fed in markets and probably even politics is whether a disinflationary trend is emerging X gasoline. Macro Alf agreed with this main point from Joe about what matters to the Fed. Last week, he wrote, the more volatile items ZG used cars in the CPI basket are declining, supply chain seemed to be easing and gasoline prices retracted a bit. So yes, inflation is likely,

Starting point is 00:05:02 quote unquote, peaked. But for the Fed, it's all about month-over-month core inflation now. So what happened? Well, a surprise to the upside. The report came in hot. Headline inflation was up 0.1% month over month, and core inflation was up 0.6% month over month. That's compared to an expected 0.1% headline drop and a 0.3% gain. So instead of month-over-month inflation decreasing, we add a slight increase in the headline number, and in the core number, the increase was twice what economists expected. Year over year, headline inflation was 8.3%, which was down slightly from 8.5% in July, but above nearly all economists estimates.

Starting point is 00:05:45 Core inflation was up 6.3% annually and 0.6% monthly, as I mentioned a moment ago. Core inflation was up 5.9% in July, and economists expected core inflation to be up 6.1% instead of the 6.3% we got in August. Now, as you might imagine, markets reacted instantly. Bitcoin was down between 4% and 6%, Eth down 7.5%. Stocks were down more than 3%, coming close to reversing gains from the 4-day rally, and NASDAQ was down 4%. Alex Kruger wrote dreadful core CPI numbers. The 0.3 month-over-month missed should deliver. delay any Fed pivot by at least two months. Short should have it easy for a while. Buy the dip can wait. Nexo is a security first platform built for the long run with everything you need for your crypto. Five key fundamentals, including real-time auditing and insurance on custodial assets,

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Starting point is 00:08:13 Digging into the headline also made it look worse. Seema Shaw, the chief global strategist at Principal Global Advisors, said, Headline inflation has peaked, but in a clear sign that the need to continue hiking rates is undiminished, core CPI is once again on the rise, confirming the very sticky nature of the U.S. inflation problem. In fact, 70% of the CPI basket is seeing an annualized price rise, of more than 4% month-on-month. Until the Fed can tame the beast, there is simply no room for a discussion on pivots or pauses. Matt Perrin, the director of research at Janice Henderson investors, says the CPI report was an unequivocal negative for equity markets. The hotter-than-expected

Starting point is 00:08:48 report means we will get continued pressure from Fed policy via rate hikes. It also pushed back any Fed pivot that the markets were hopeful for in the near term. James Athi, the investment director at Aberden, said, the recent bounce in equities looked incredibly ill-judged and premature. Indeed, one of the ironies is that the market's recent rally makes the Fed more likely rather than less likely to continue their hawkishness. The Fed deals in psychology and really needs to convince markets it's willing to do what it takes for however long it takes for prices to come down. Sylvia Delangelo, a senior economist at Federated Hermes, says, while there's been some easing in long-term inflation expectations, recent data still overall

Starting point is 00:09:25 point to a picture of high inflation in a tight labor market. This implies the risk of inflation becoming entrenched via second round effects is still elevated. Accordingly, the Fed will likely stick to its hawkish trajectory in the coming months. So digging into the numbers a little bit, there was a section of the report that really captured what was going on. Quote, increases in the shelter, food, and medical care indexes were the largest of many contributors to the broad-based monthly all-items increase. These increases were mostly offset by a 10.6% decline in the gasoline index. The food index continued to rise increasing 0.8% over the month as the Food at Home Index rose 0.7%. The Energy Index fell 5.0% over the month as the

Starting point is 00:10:06 gasoline index declined, but the electricity and natural gas indexes increased. The index for all items less food and energy rose 0.6% in August, a larger increase than in July. The indexes for shelter, medical care, housing furnishings, and operatings, new vehicles, motor vehicle insurance, and education were among those increased over the month. While there were some indexes that declined in August, including those for airline fares, communication, and used cars and trucks. trucks. Basically, energy and the things that use energy showed the best sign of inflation declining, but everything else just went up. Health insurance saw its biggest year-over-year increase ever at 24.3%. Food at home was up 13.5%, which is, of course, a particularly painful number for people

Starting point is 00:10:48 who are struggling to make ends meet. Rent prices were up 15.8% year-over-year. Month over month, shelter rose 0.7%, which was the biggest monthly increase since 1991. So how, how do you? How do you How does that square with the private sector data I shared yesterday that saw Q2 rental numbers down relative to the previous two quarters? Well, one, either there was a course correction or two, one of the data sets is wrong. And this is the challenging thing about statistics. We just don't know. Now, overall, services inflation was above 6%, and that's probably one that the Fed is paying

Starting point is 00:11:19 particularly close attention to, even relative to others. Bloomberg's senior editor John Authors shared a chart and wrote, This chart shows why CPI number is so disappointing. The contribution of energy has declined as expected, but services inflation is now rising sharply, not what the FOMC will have wanted to see. Lin Alden quote tweeted this and said, because the inflation wasn't just supply chain issues. It was also the fiscal and monetary component. Flooding the system with broad money resets aggregate prices higher permanently.

Starting point is 00:11:48 Another issue that some are bringing up is that the declines in energy are not just natural, but also involve government intervention. Joe Wisenthal, again, writes, the biggest deflationary impulse is oil, and it seems very very likely that the SPR release has been a contributor to that. Seems like a risk if the out-month purchase commitments aren't made firm that the SPR effect eventually fades, and you're just left with depleted stocks. Now, on the other side of all of this, rate expectations are going up. Mohamed El-Irion said, last week Fed officials signaled more constantly that rates would go higher, not just for longer, but also in a faster way. Today's hot inflation numbers,

Starting point is 00:12:21 both headline and core, reinforce that likelihood and make a third 75-bases-point hike, historic in several ways, a done deal. Jim Bianco writes a 75 basis point hike is 100% priced in for September 21st, bringing the rate to 3 to 3.25%. Again, the Fed has never failed to deliver on something 100% priced in. What about the next meeting on November 2nd? The market now has a fourth consecutive 75 basis point hike to 3.75 to 4% above 50%, meaning it is expected. Now even more than that, a couple hours after this print, Nomura became the first bank to suggest the Fed would go all the way to 100 basis points this meeting. And however after that, odds of a full percentage point hike were up 30% and rising. The overall number where investors think the Fed will land is going up as well.

Starting point is 00:13:06 Bloomberg reports that investors are pricing in 4.3% as the terminal federal funds rate, up from under 4% recently. John Turrick writes, I'm in the camp that this was more of a setback than a reset, but this is a big reset. I think the pricing assumption now has to be 75, 75, 75, 50, 25, which is massive shift from the potential of 75, 50, 25, pause. Market now has to bear that adjustment. In terms of the human cost, the average American household is now spending $460 per month more than last year at this time on goods and services. And the real question underlying this is, of course, what can be done. The market is looking to the Fed is the sole vehicle to fight inflation, but it brings up real questions, not about the

Starting point is 00:13:46 Fed's commitment, but about their capacity and the timeline. They're living in a media world, with constant unceasing pressure to fix this now. That brushes up uncomfortably against the time it takes for macro factors to change. One of the questions that some are airing, even as inflation remains persistent, is will the Fed over-tightened because of pacing issues and pressure? Marcus Obsfeld from the Peterson Institute for International Economics wrote a piece this week called Uncoordinated Monetary Policy's Risk a Historic Global Slowdown. He begins the piece,

Starting point is 00:14:15 Central banks nearly everywhere feel accused of being on the back foot. The present danger, however, is not a lot of the moment. not so much that current and plan moves will fail eventually to quell inflation. It is that they collectively go too far and drive the world economy into an unnecessarily harsh contraction. Just as central banks, especially those of the richer countries, misread the factors driving inflation when it was rising in 2021, they may also be underestimating the speed with which inflation could fall as their economy's slow. And, as often is the case, by simultaneously all going in the same direction, they risk reinforcing each other's policy impacts without taking that

Starting point is 00:14:47 feedback loop into account. Now, the politics of all of this are very rough, particularly if you're a Democrat. Biden tweeted, today's data shows progress in fighting inflation. This month, prices overall were essentially flat, gas prices were down, and wages were up. That's good news for American families. My plan is showing we can lower costs, create jobs, and bring manufacturing back to America. He also said that it would take a little more time. It doesn't really seem like too many people are buying that message. So, summing up today, one, these inflation numbers were surprised. Maybe they shouldn't have been, but they were. As the Wall Street Journal put it, in light of the drop in gasoline prices, retailers' efforts to clear out bloated inventories, easing supply chain woes and reports

Starting point is 00:15:27 of price declines and everything from freight rates to use cars, the feeling going into Tuesdays seemed to be that the report would confirm inflation was in a cooling trend. End quote. Obviously, that's not what happened. Second, as we've discussed, this is bringing up questions about what's really going on and what the Fed can do. Third, it's making us recognize other crappy parts of the economy. The U.S. Census Bureau today also released its annual report on the nation's financial well-being and showed that median household income was essentially unchanged this year. Finally, all of this is increasing the odds of a recession. The Wall Street Journal concluded an analysis of today's event saying, whatever your odds on the danger of the Fed sending the economy

Starting point is 00:16:03 into a recession were before Tuesday, they should be higher now. Deutsche Bank, which was the first Wall Street bank to forecast a recession all the way back in April said, our view is that the pessimists will sadly prevail on this occasion. Their reasoning is monetary policy lags, arguing that monetary policy tends to lag roughly a year, meaning this rate hiking hasn't really made its way through the economy yet. Second, a tight labor market, which makes it much harder for the Fed to get its job done. And third, the fact that too much progress in inflation has been on outliers, specifically energy, rather than a broad-based disinflationary trend. So there you have it. Unfortunately, basically the worst type of report to have to give. But it is what it is. And we're

Starting point is 00:16:42 are where we are. For now, I want to say thanks again to my sponsors, nex0.com.com. Chainalysis and FTX for supporting the show. 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 ideas. 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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The Breakdown - Markets Plummet as Inflation Comes In Hot

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