The Breakdown - No Pivot and Higher Terminal Rate Talk at FOMC Send Markets Back Down

Starting point is 00:00:00 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 F-TX, and produced and distributed by CoinDesk. What's going on, guys? It is Thursday, November 3rd, and today, you know we're talking about yesterday's 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. Also, a disclosure, as always, in addition to them being a sponsor of the show, I also work with FTX.

Starting point is 00:00:49 All right, folks, well, yesterday was Fed Decision Day, so obviously we are going to hone in on if and how it shifted the narrative, how markets reacted, and of course, what people think about what's going to happen next. But to get into this, let's actually back up and look a couple days going into the meeting. One of the big questions around monetary tightening has been whether or not removing liquidity from the system would create major breakages that would force the Fed back to a more accommodative stance. On that front, growing concerns about the lack of liquidity in the Treasury bond market has led to another round of speculation that the U.S. Treasury could intervene with buybacks if the situation continues to deteriorate.

Starting point is 00:01:30 A Wall Street Journal article last week said that for now, the January, Bennett-Yellen-led Treasury is simply researching what an intervention could look like. Yet some bank analysts are already raising the alarm. Andrew Kreacher, a director at Wells Fargo, says that liquidity in the treasury market is the worst he's recently seen, adding, quote, there are so many systems in other asset classes that use treasuries as a building block. If you have rotten the foundation, the whole house is at risk. Jim Caron, a fixed-income portfolio manager at Morgan Stanley Investment Management

Starting point is 00:01:59 said, if the treasury market isn't working, nothing is working. Others aren't sure. Some have pointed out that we may be simply looking at a market that's repricing continuous Fed rate hikes and the volatility associated with that policy. Stephen Abraham's, senior managing director at Amherst Pierpont Securities, said, quote, we're seeing plenty of concerns about liquidity, but it's coming at the same time that we're seeing real concerns about volatility, and it's very difficult to untangle those things. Now, were this to happen, the Treasury policy would likely be to purchase older and less liquid treasury bonds, issuing new bonds which are more desirable as collateral to fund the purchases.

Starting point is 00:02:35 While some argued that the policy could have a similar effect to quantitative easing or QE, the real impact on such a policy is extremely unclear. Life of Palk writes on Twitter, simply put, Treasury is being forced to buy back treasuries that have not matured because liquidity metrics for the U.S. government debt market are approaching crisis levels after a year of steep losses for bonds caused by rising inflation and Federal Reserve interest rate increases. Rao Paul writes, when the Fed or the Treasury figures out a way of getting banks out of the reverse repo market, people will say it's not QE, but it is a huge liquidity-creating event.

Starting point is 00:03:07 Watch this carefully. Now, the main takeaway right now is probably less the details and more about where the chatter is. In other words, it's more about questions than answers. Is the Treasury taking on monetary policy-like actions? Are the Fed in the Treasury pulling in opposite directions regarding tightening liquidity? And just how much of a problem is illiquidity in the treasury market? But now let's get a little bit closer to the Fed and talk about what the discourse was like heading into FOMC Day. One of the things that's been a common thread of Powell and Fed discussions, basically all of late summer and fall, is the idea that, one, the Fed needed to be data driven and responsive to

Starting point is 00:03:42 new data coming in before determining anything about what they're going to do with rates, and two, one of the most important sources of data was around the labor market and whether it was showing any signs of loosening. Employment has remained stubbornly full, which seems like it should be a good thing, but in the context of Fed policy means that they're convinced they have more room to tighten. and on top of that, remain terrified of a wage price spiral. So one question, heading into any FOMC meeting, is whether there's any evidence to suggest that the labor market is getting worse

Starting point is 00:04:10 and thus better if you're an investor hoping for the Fed to start backing off. The job openings in Labor Turnover Survey or Joltz report for September was published on Tuesday, and the results could not have been worse for a Federal Reserve looking for signs of a slowing labor market. The number of available positions moved up to $10.7 million from $10.3 million the month prior, moving in the opposite direction of economists' forecasts that were aggregated by Bloomberg, which called for a drop to 9.8 million openings. Even more importantly, the ratio of openings to unemployed people rose from 1.7 in August to 1.9 in September. This ratio was noted as a key indicator of labor market tightness by Fed Chair Jerome Powell throughout this year. Job openings for

Starting point is 00:04:52 August were also revised up by about 200,000 on review. Economist Eliza Winger said job openings failed to decline in September despite clear signs of slowing economic momentum, complicating the picture for a Fed looking to take excess heat out of the labor market. Nick Bunker, head of economic research at Indeed Hiring Labs, said in a note, After the shock of last month's report, the September Jolt's data is returning to a familiar story. Demand for workers remains robust. By all the key metrics in this report, the labor market is resilient. Now, the full jobs report for September is due on Friday, and economists forecast an additional 1190,000 jobs will have been added to the economy. Nick Timrose of the Wall Street Journal,

Starting point is 00:05:31 who has often looked to as a source of Fed narrative, tweeted about this, saying the number of job openings in September rose by 437,000 to 10.7 million, and the August figure was revised up by 200,000. The Fed would like to see the ratio of vacancies to unemployed workers decline, and it ticked up in September to 1.86 from 1.68. This comment caused macro in growth to say Nick has made a sharp U-turn in tone since last Friday. Dot, dot, dot, dot. Now, as I mentioned, in lieu of actual Fed speak, the markets often look to Nick.

Starting point is 00:06:02 When he hints at dovishness, markets react positively. Apparently, the opposite is also true. Want to keep more profits when trading? Get the best possible prices and trade with 50% lower fees on NXO Pro. The new Spot and Futures trading platform uses aggregated liquidity of over 3,000 order books collected from multiple sources.

Starting point is 00:06:27 Utilizing the complete nexo suite allows you to earn interest and borrow funds as you wait for the next trade setup. Visit pro.nexo.io. That's p.r.0.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 a leader in crypto, and has a leader in crypto that's 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,

Starting point is 00:07:11 and compliant with regulations. Just go to circle.com backslash transparency to see why USDC is a trusted staple coin. The breakdown is sponsored by FTXUS. FDXUS is the safe, regulated way to buy and sell Bitcoin and other digital assets, with up to 85% lower fees than competitors. There are no fixed minimum fees, no ACH transaction fees, and no withdrawal fees. One of the largest exchanges in the U.S. FDXUS is also the only leading exchange that supports both Ethereum and Solana NFTs. When you trade NFTs on FTCS, you pay no gas fees. Download the FTCX app today and use referral code breakdown to support the show. So given all this, were people expecting another big hike and in short the answer is yes.

Starting point is 00:08:02 The hike was a fairly foregone conclusion. Instead, what folks were really focused on was what the qualitative statements would be around how the Fed was thinking about going forward. For example, heading into the meeting market indicators were split on whether to expect a 50 basis point hike or another 75 basis point hike in December. A team of Bloomberg economists said, The Fed is widely expected to hike rates by 75 basis points for a fourth consecutive meeting. Less certain is how Fed Chair Powell will communicate a potential future downshift in the rate hike pace. The degree of conviction, the risks around hike sizing, and implications for the term of the termination, rate. We expect that he will present a 50 basis point move as the base case and clarify that a

Starting point is 00:08:38 downshift in the pace of rate hikes does not necessarily mean a lower terminal rate. Now, of course, when it comes to any speculation around what the Fed is going to do in December, the reality is there is a lot of economic data to come in between now and then. There are two jobs reports and two inflation reports before that next FOMC meeting. Anna Wong, the chief U.S. economists at Bloomberg said, I think the most important thing to watch for is how Powell communicates the potential downshift and the pace of rate hikes. He will want to avoid giving the impression that a pivot is imminent, especially not when core inflation is clearly still going strong. He would be preparing the market for a 50 basis point hike in December, but which will also be accompanied

Starting point is 00:09:15 with a dot plot, which shows a 5% terminal rate. Now, even before the FOMC presser, this question of the terminal rate was on people's minds. Nick Timoros again says one source of confusion for some investors recently is how Fed officials could contemplate slowing the pace of rate rises, even if estimates of the peak rate creep higher. The obvious dilemma for financial markets is many things can be true simultaneously. For example, strategists at FHN Financial expect the Fed to hike to 6% by next June. After this week's increase, the Fed could accomplish that without another 75 basis point rate rise. Now, the other tricky thing for the Fed going into this is that markets are so desperate for a sign of a pivot, the Powell has to be extremely careful with his words.

Starting point is 00:09:55 Numerous times, we've seen a situation where the markets get out ahead of where the Fed is. and the market rallies that ensue actually makes monetary policy harder to do its job. Greg Spence writes, one way not to get a Fed pivot is by taking a four-week, 15% parabolic rally into FOMC, built on yet another flimsy pivot narrative orchestrated during Fed blackout. DeBulls realized this is the sixth time they've played this exact game? So at this point, I think we should actually look at what news came out of the Fed. The short of it is that they're staying in the course. We got another 75 basis point hike, with Powell saying we continue to anticipate that ongoing increases

Starting point is 00:10:29 will be appropriate. We are moving our policy stance purposefully to a level that will be sufficiently restrictive to return inflation to 2%. In addition, we are continuing the process of significantly reducing the size of our balance sheet. Now, on inflation, Powell flagged that it's sticky, but expectations remain okay, but that that could change. Quote, recent inflation data again have come in higher than expected. Price pressures remain evident across a broad range of goods and services. Despite elevated inflation, longer-term inflation expectations appear to remain well anchored, as reflected in a broad range of surveys of households, businesses, and forecasters, as well as measures from financial markets. But that is not grounds for complacency.

Starting point is 00:11:06 The longer the current bout of high inflation continues, the greater the chance that expectations of higher inflation will become entrenched. When it comes to growth, Powell said that although, quote, the U.S. economy has slowed significantly from last year's rapid pace, labor remains the issue. Putting a fine point on this, Powell said the labor market continues to be out of balance with demand substantially exceeding the supply of available workers. And what about a pause or an acknowledgement of policy lag? On that front, Powell said, it will take time for the full effects of monetary restraint to be realized, especially on inflation. That's why we say in our statement that in determining the pace of future increases in the target range, we will take into account

Starting point is 00:11:43 the cumulative tightening of monetary policy and the lags with which monetary policy affects economic activity and inflation. At some point, as I've said at the last two press conferences, it will become appropriate to slow the rate of increases as we approach the level of interest rates that will be sufficiently restrictive to bring inflation down to our 2% goal. Now, some of this talk was initially taken by the markets as bullish. The headline was that the Fed says it will take cumulative tightening and lags into account. Alex Kruger tweeted that headline and said, excellent. If Powell doesn't mess it up, should get an upwards trend out of this FOMC.

Starting point is 00:12:15 By explicitly mentioning lags in the data, the FMC statement validated the micro-pivot from two weeks ago. Now waiting for the press conference and, if nothing new, cleared or run. That's a big if. So did it happen? The short answer was nope. And the biggest thing that shifted the market's take on this FOMC meeting were comments from Powell that new data that they had received since the September meeting suggested that the terminal rate, the peak interest rate, that they believed would be required to get

Starting point is 00:12:41 inflation down, had gone up. This led to something of a case of Fed Day whiplash. The S&P 500 rose by almost 1% in the five minutes after the FOMC's statement on interest rates was released, as I mentioned being viewed as confirmation of a doveish slowing of rate hikes on the horizon. However, when Fed Chair Powell took the stage half an hour later adopting a hawkish tone, the markets began to slide, dropping 3.3% to close the day down to 1⁄2%. Bitcoin traded in a similar way, round-tripping a spike, then a dump, to end the day down half a percentage point. Here's how macro analyst Paulo Macro summed this up. Okay, quickly on the Fed. No pause coming.

Starting point is 00:13:18 Higher terminal. Four handle is off the table. Sorry, bros. likely as what was said among many other things. What was unsaid? One, he was asked about plus 50 in December and he dodged saying it's about the pace, what level we get to and how long we stay there. But he left it open. He also left 75 open and implicitly left 100 basis points open. He does not know. The road is wide open. And that is massive uncertainty risk to the path in the context of a higher terminal. This means risk premium must go up to account for varied outcomes. When the future becomes more uncertain in terms of path, risk premium go up. And then, when asked about whether rates need to go positive real, he said they try to use forwards, that is what traders say

Starting point is 00:13:57 inflation is. Unsaid, eventually there needs to be convergence between what the market price is in with reality. Inflation is where it was a year ago. If he needs to go to 8%, 3% real, he will do it because he has an alphabet soup of programs he can use to pick up the pieces. He would rather break stuff and then patch it back together because that is easier than letting it get entrenched. This was the most hawkish conference of the year. If you didn't get the memo and our long equity risk, especially of the duration kind, you are dancing on a cliff's edge juggling chainsaws without a net or gloves. Paula was not alone in focusing on the overtightening discussion. Qasim Khan quoted Powell saying, if we overtitin, we can use monetary policy tools to support

Starting point is 00:14:36 the economy. But if we don't tighten enough, inflation becomes entrenched. The guy can't be more crystal clear. Brent Johnson quote tweeted that and said this point is important to understand. These psychos are so arrogant that they believe they can save the system after they purposefully crash it, and there is great risk to both Powell and the Fed itself if it tightens too soon, even if pivoting is the right thing to do. Later, Brent Johnson said, I don't know how he could possibly be more clear on what he intends to do. He may fail, but there should be no confusion with regard to the message. So now where we're left is the markets making sense of what a terminal rate in the fives or even the 6% range could actually mean. They're trying to make sense of a Powell who is more hawkish than ever.

Starting point is 00:15:14 I do think there is a big part of his hawkishness that is over-expressing it because the market is so hungry for any signs of dovishness. Whatever the case, the key things now are two more jobs reports and two more inflation prints before the December meeting. Until we get those, it's business as usual, and business kind of sucks. For now, I want to say thanks again to my sponsors, nexus.com, circle and FTX, and thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace.

The Breakdown - No Pivot and Higher Terminal Rate Talk at FOMC Send Markets Back Down

There aren't comments yet for this episode. Click on any sentence in the transcript to leave a comment.