The Breakdown - Now at 9.1%, Inflation Just Keeps Going Up

Starting point is 00:00:00 Today's data does not reflect the full impact of nearly 30 days of decreased gas prices, which comes straight from a Biden quote after the inflation print went live. I got to say the market really isn't buying this one. It's something like, transitory once, shame on you. Peak inflation because of gas twice, shame on me. 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, chain aliasis, and FtX, and produced and distributed by

Starting point is 00:00:36 CoinDesk. What's going on, guys? It is Wednesday, July 13th, and today is Inflation Day. Before we dive in, a quick note, there are two ways to listen to the Breakdown podcast. You can find us on the CoinDesk Podcast Network feed, which features the breakdown alongside other great shows. That comes out each afternoon. Or you can listen on the Breakdown-only feed, which comes out a few hours later. In either case, if you're enjoying the show, please consider leaving a rating or a review. It makes a huge difference, and I appreciate them all.

Starting point is 00:01:08 Also, a disclosure as always. In addition to them being a sponsor of the show, 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?

Starting point is 00:01:27 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 Core wallet in just a few clicks. Go to core.com. app to access the full power of Web3 on Avalanche. All right, friends, here we are. It is CPI Day, and it is a doozy. But before we get into today's inflation print, let's talk about where we have been.

Starting point is 00:02:04 Coming into June, the expectation was that the Fed was going to hike rates by 50 basis points a half percent in both June and July. That was until the May CPI print came in hotter than expected, and those expectations were revised up. In the days leading up to last month's FOMC meeting, the Fed started signaling that rather than the 50 basis point hike that everyone had already priced in, there was more consideration for a 75 basis point hike. This was really reinforced by Nick Timoros of the Wall Street Journal, when he published a piece entitled Fed likely to consider 0.75 percentage point rate rise this week. Now, Nick in many ways is considered to at this point effectively be the media communications arm of the Fed, so his article was taken by the market correctly

Starting point is 00:02:51 to be a fairly strong indication that a 75 basis point hike was coming. That is in fact exactly what happened and it was the biggest hike since 1994. To get a sense then of how the discussion has evolved over the last month, it might be worth going to read another Nick piece from over this weekend. It was titled, For the Fed, Easing Too Soon, risks repeat of stop and go 1970s. The article communicates a view of Fed policy from that era suggesting that by backing off from rate hikes too early, inflation came rushing back. as soon as the Fed took its foot off the break.

Starting point is 00:03:23 Looking at the data, you see clearly that the Fed hiked alongside increased inflation and then chickened out, basically, before peak inflation was reached, multiple times. Eventually, this led to Arthur Burns being disgraced and replaced by Paul Volker, and the Volker Fed deciding that they needed to hike rates hard and fast, which eventually broke the U.S. economy with 10% unemployment to kill off inflation for good. The article explains that this reading of history could mean that the Fed will be looking to hike well past peak inflation. It also takes the view that the Fed is better off overdoing their inflation fight the first time around to ensure that the U.S. economy does not have a lengthy inflationary

Starting point is 00:04:00 decade like it did in the 1970s, even to the point of harming the labor market. This is going to be relevant to the discussion of what comes next, but of course we have to get there first. We started to get some hints at the beginning of this week that June's inflation numbers might be higher than the market expected. On Monday, White House press secretary Kareen John Pierre gave a press conference about this week's inflation data release. She said that inflation data was expected to be, quote, highly elevated, but at the same time noted that gas prices had increased significantly in June, but have come down by about 7% since then. She also made the point that CPI data is backwards looking. Effectively, she was setting up a scenario where she was preparing the

Starting point is 00:04:40 markets both for a higher than expected CPI print, but also a narrative explanation as to why wasn't as scary as it seemed. Now, before we get into what numbers we actually got today, let's look at one more piece of commentary from Alex Kruger. He wrote this morning about 90 minutes before the numbers came out, my take on today's highly anticipated CPI inflation data. The last CPI number triggered a massive crash, with the S&P falling 7% in two days. Meanwhile, the ensuing crypto crash was so intense that CPI could be relabeled as the crypto pain index. Bitcoin an eth dropped 30% and 40% respectively in four days, leaving many traumatized. This likely makes today's CPI the most watched inflation number in history. Such a crash is very unlikely to

Starting point is 00:05:26 repeat itself for five reasons. Number one, the crash was driven not only by a high print, but more importantly by a large beat of consensus. Number two, the market is already expecting a very high print, higher than in June, and has already sold off considerably since Sunday in anticipation. Number three, inflation is expected to fall considerably from here, mainly due to falling gas prices. Number four, today's CPI is unlikely to change the Fed's reaction curve, which is what truly matters. The Fed is seemingly set on a 75 basis point hike in July, which is fully priced in. July's FOMC should be a minor event, with all eyes on September's FOMC. No FOMC in August as boomers take a month off. Number five, when it comes to crypto, much of the industry has already

Starting point is 00:06:10 capitulated. I expect CPI higher than consensus, and thus the ensuing dip to be faded rather than start a new downtrend. So let's talk then about what actually happened. The banner headline is that the consumer price index rose 9.1% year over year in June. It's the largest gain in 41 years since the end of 1981. The month-over-month gain was a 1.3% jump, which is the highest since 2005. The key aspects of this inflation print were higher gasoline. lien costs, higher shelter costs, and higher food costs. You know, three fairly non-essential categories. As we know, however, what matters in many ways more than the numbers themselves, at least in terms of short-term market reaction, is how they came in relative to expectations.

Starting point is 00:06:55 Economists had projected the month-over-month would be 1.1% and the headline would be 8.8%. That's versus the 1.3% and 9.1% they were, respectively. So we came in with a hotter inflation print than expectations. Now, the other number that people watch is the core CPI, which strips out food and energy, which are more volatile. Those are up 0.7% month over month and 5.9% year over year. A few of the key areas. Gas prices rose 11.2% in June from a month earlier. Energy services, including electricity and natural gas, increased 3.5%, which was the most since 2006. Food costs are up 10.4% from a year ago, again the largest since 1981. Both goods and services are on the rise. Goods were up 2.1% in a month and services were up 0.9%. That was the biggest

Starting point is 00:07:43 month-over-month service price jump in 21 years. Rents are also up 0.8% from May, which is the largest monthly increase since 1986. Owner-equivalent rent increased 0.7%, which is the most in 32 years. Hotel and airline fares fell May to June, but that's coming off of historic increases. And maybe most important of all, higher prices are absolutely chomping wages. Inflation-adjusted average hourly earnings dropped 3.6% in June, which is their 15th straight decline. For the first time, we're starting to actually see this show up and impact expenditures. Inflation-adjusted consumer expenditures fell 0.4% last month, which is the first decline this year. In times like these, security of your assets should be your number one priority.

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Starting point is 00:09:58 When you trade NFTs on FTCX, you pay no gas fees. Download the FTCX app today and use referral code breakdown to support the show. Let's talk interpretation, and first let's give the hopeful spin. The key thing was exactly what was previewed by the Biden administration earlier this week. And that's that we've likely reached some sort of peak inflation because of how much of this particular print is driven by gasoline. Paul Krugman, for example, writes, Today's hot inflation number is already out of date, not reflecting falling gasoline prices and other factors that have recently gone into reverse.

Starting point is 00:10:33 Itoro went so far as to make a playlist where the songs titles Together spell, today's data does not reflect the full impact of nearly 30 days of decreased gas prices, which comes straight from a Biden quote after the inflation print went live. I got to say the market really isn't buying this one. It's something like, transitory once, shame on you. Peak inflation because of gas twice, shame on me. Anyways, not everyone is so optimistic about this, with Bloomberg's headline being very bad.

Starting point is 00:11:03 Ultra-hot inflation print sends markets reeling anew. And look, the obvious big thing here is that this is going to justify the Fed's continued push to raise rates and tighten monetary policy. Looking at what the Fed might do next, Art Hogan, the chief market strategist at National Security, says, investors look at this and say, what does this change? The biggest thing it changes is what the Fed might do in September, and that's moved higher. That was a 60-40 proposition, with 50 basis points being in the majority there, and now it's leaning closer to 75% chance that the Fed's going to go three-quarters of a percentage point in September. Sam Stovall, the chief investment officer at CFRA, goes even further, saying it means that the Fed will

Starting point is 00:11:42 be raising rates by 75 basis points not only at the July meeting but also at the September meeting, and that the jury is still out as to what's going to happen in the final two meetings of the year. But I think three-quarter hikes are definitely in the cards. Ian Lindgen, the head of U.S. rate strategy at BMO Capital said, overall, this was another stronger than expected print, similar to May's data and investors will be eagerly awaiting any sign that the Fed will seek to step up the pace of hikes yet again. It's unsurprising to see August Fed Fund's contract now pricing in more than 75 basis points, and we expect the conversations regarding a 100 basis point hike to pick up in earnest. Not our base case, but we were surprised in June with the

Starting point is 00:12:21 upsized hike, so are waiting on any incoming Fed speak to clarify the committee's thinking on the pace of tightening. Now, in an interview from yesterday, Warren Buffett had said in advance to the print that he expected to see 10% inflation and a 100 basis point hike as the resulting. It seems like Mr. Buffett is not alone. As Dylan LeCearnes points out, the futures market is now assigning a 44% probability of a 100 basis point rate hike at the next FOMC meeting. This is up from just an 8% probability yesterday.

Starting point is 00:12:52 And even as I was preparing this podcast, I had to keep coming back to this section to add to it. As I was writing, Nomura Policy Watch published a piece called we expect a 100 basis point hike in July. The Fed remains extremely data dependent, and the data suggests a larger rate increases needed. June CPI data cement the need for an even more aggressive Fed, and we now expect a 100 basis point hike in July. Let's go back, though, to what Kruger thought that this wasn't going to be the start of a new downtrend. He said he was surprised at how much to the upside the print came in, but that this was, quote, still not a defining trend. July

Starting point is 00:13:29 rate hike odds barely changed, but think good enough to keep downward pressure for the rest of the week on equities and thus crypto as well. However, there is another interpretation that I think is getting more salient and more relevant for the conversation. Neil Duda, the head of economics at Renaissance macro research, says, given my readings of the Fed's reaction function, the odds of recession are going up and the likelihood of a pivot is going down given today's CPI inflation data. The Kobayisi letter, a macro newsletter said widespread selling of commodities is suggesting that inflation will peak over the coming months. With rapidly raising rates, the housing market will be the next segment to turn lower. As inflation dials back, we begin a new era of economic weakness. Deflation is coming

Starting point is 00:14:10 fast. And if you think that means that the Fed is going to have to reverse course, I am not sure. Hidden Forces Demetri Kofenis writes, I've expressed this view since late summer, early fall of 2021, that markets were underestimating how aggressive the Fed would be in tightening and how how little it would care about asset prices. I do expect that there's going to be more recession chatter as a chief narrative, but I just don't expect it right now to change the Fed's perspective. Returning to a quote we used after last month's FOMC meeting, Diane Swank, the chief economist at Grant Thornton, said, this is a Volker-esque Fed. That means the Fed is willing to take a rise in unemployment and a recession to avert a repeated mistakes of the 1970s. Supply shocks won't

Starting point is 00:14:52 correct themselves, so the Fed must reduce demand to meet a supply-constrained world. Harold Momgren, who is an economist and geopolitical strategist, and who was a senior aide to Presidents Kennedy, LBJ, Nixon, and Ford said, people closest to Powell believe he is determined not to be known in history as, quote, another Arthur Burns. Thus, he will likely be last FOMC member to pivot after recession severity changes majority vote. Not saying it, but see severe recession as necessary. You'll remember Arthur Burns was the Fed chair who was later replaced by Paul Volker. And to all the folks citing their preferred metric or benchmark for why the Fed has to shift course at this point, I'd cite Macro Alf, who tweeted, trying to call the Fed

Starting point is 00:15:32 pivot by back-testing against the last 10 years is a guaranteed way to lose money in this cycle, in my humble opinion. This time, the Fed will turn dovish only when they'll be confident enough to have killed inflation, not only slowed, but killed for good. There are, however, recession indicators flashing. Oil futures are down 7% in the last week. Copper, which is typically seen as an extremely good predictor of global slowdowns is down over 20% in the last month. Wheat is down almost 20% so far in July. And this is just the tip of the iceberg. Most commodities other than European natural gas have fallen so far this month. Certainly, recession is going to be the media's new line.

Starting point is 00:16:10 CNBC just published a piece about how Bank of America is now calling for a mild recession, not a more dramatic collapse like the Great Recession that began in late 2007. So there you have it. We have a new narrative competition. It's inflation peaking versus recession. It's get demand down so this inflation doesn't get worse, versus yeah, but do we have to destroy jobs to do it? In the immediate term, I think, like we were seeing, even in the course of this show,

Starting point is 00:16:35 we're going to see far more calls for a 100 basis point hike, a full percentage point hike at the FOMC meeting later this month, and in general, the moment continues to be tough. For now, I want to say thanks again to my sponsors, nexo.io, chain aliasis, FtX, and Avalabs. and thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace.

The Breakdown - Now at 9.1%, Inflation Just Keeps Going Up

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