The Breakdown - Powell Dismisses Inflation Concerns

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. What's going on, guys? It is Thursday, May 2nd, and today we are talking FOMC and Macro. 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. Hello friends. Today we are digging deep in the macro landscape. Yesterday was the weirdest thing I've ever seen. That's probably hyperbole, but it was weird. Basically, we had a Fed meeting that on the one

Starting point is 00:00:48 hand felt like a complete nothing burger, but also felt like Fed chair Jerome Powell really trying to buck against an emerging narrative. So let's talk about what happened and then we can get into all of that. Wednesday's FOMC meeting saw the Fed sticking to the current path despite fears of renewed inflation. Rates were held steady between 5.25 and 5.5%, which is the same level they've been at since July of last year. The only change was a slowdown in balance sheet runoff for quantitative tightening. Starting from June, $25 billion worth of treasuries per month will be allowed to mature and fall off the Fed balance sheet. The process was previously running at a rate of $60 billion per month. The roll-off of agency mortgage-backed securities will continue at the current pace.

Starting point is 00:01:26 Overall, the tone was that the recent uptick in inflation has been noticed but isn't a reason for concern at this stage. This was evident in small-churchase. changes to prepared remarks from Fed Chair Jerome Powell, particularly the omissions. At the previous FOMC meeting in March, the focus had been on figuring out when rate cuts could be expected. Powell had said the committee is looking for further data to provide confidence that rate cuts would become appropriate soon. This time, Powell said that, quote, so far this year, the data have not given us that confidence. Instead, the focus was on current policy being appropriate to deal with the risks facing the economy, both the risks of rising inflation and the risk of an

Starting point is 00:01:59 unexpected softening in the labor market. Powell emphasized that the committee now views these risks to be in balance and is confident they can adjust policy to deal with whatever comes next. Throughout the press conference, Powell downplayed the risk of inflation. His forecast was that inflation is still heading down. He noted that lower rents are still working their way into the data and that he believes there are still gains to be made from supply chain normalization. A deterioration in the labor market seemed to be the more pressing issue. While Powell was not concerned by current data yet, he emphasized that the FOMC is, quote, prepared to respond to an unexpected weakening in the labor market. One of the big themes of the meetings was the paths the

Starting point is 00:02:32 economy could take from here. Rather than simply talking about being data dependent, Powell used this concept of paths to explain where Fed rates might go next. He said, if we did have a path where inflation proves more persistent than expected, and the labor market remains strong, that would be a case where it could be appropriate to hold off on rate cuts. Regarding the path where it would be appropriate to cut rates, Powell laid out two scenarios. First was simply gaining greater confidence that inflation is coming down to 2%. Powell added, another path could be an unexpected weakening in the labor market. It will really depend on the data. And then here is where we got the biggest divergence from the emergent narrative, let's call it, well, at least the Twitter part of the financial

Starting point is 00:03:09 markets. Although Powell acknowledged that progress on inflation is stalled out, he gave the impression that the Fed isn't currently looking at rate hikes to address it. Then again, regarding a labor market collapse, Powell gave the impression that it would need to be dramatic to spur rate cuts, stating, it would have to be meaningful and get our attention and lead us to think that the labor market is really significantly weakening for us to want to react to that. He was precise in saying that a slight rise from current levels wouldn't be enough. It was pretty clear during this press conference that the nature of questions from the press had entirely flipped. At the last meeting, the media attempted to pin Powell down on when rate cuts could be expected. He declined

Starting point is 00:03:42 to issue any guidance. At this meeting, the focus was on probing Powell on whether the Fed was doing enough to address the recent inflationary trend. Powell was insistent that current policy is appropriate and that the Fed was being sufficiently restrictive to impact inflation over time. He was asked directly what it would take to look at hiking rates, to which Powell responded, I think it's unlikely that the next policy rate move would be a hike. Our policy focus is really how long to keep policy restrictive. What would it take? I think we need to see persuasive evidence that our policy stance is not sufficiently restrictive. That's not what we think we're seeing. One journalist even went so far is to bring up the hot speculation of the moment that the U.S. is heading into

Starting point is 00:04:16 stagflation. Powell dismissed the notion, suggesting that stagflation just isn't in the current data. He said, I was around for stagflation and it was 10% unemployment, high single-d its inflation and very slow growth. Right now we have 3% growth, pretty solid growth by any measure, and we have unemployment running under 3%. So I don't really understand where that's coming from. We even got an awkward joke out of Powell on this point with him saying, I don't see the stag or the flation actually. This one is really in the eye of the beholder. On the one hand, Powell genuinely didn't seem to think stagflation is a legitimate concern. However, the odd joke and the forced laughter from the press gallery definitely gave a little bit

Starting point is 00:04:51 of a vibe of methinks the lady doth protest too much. Whatever he actually thinks, though, Powell was clear that no action is being taken on inflation for now. In fact, taking the inflation issue from the opposite angle, Powell was asked whether the Fed would be satisfied to write out the rest of the year with inflation near 3%. That question spurred a strong response, with Powell stating, 3% can't be in a sentence with satisfied. We will return inflation to 2% over time, and we think our policy stance is appropriate to do that. So, with no change in Fed rates policy likely to come anytime soon, attention turned to the effect of reducing quantitative tightening. This process of allowing government bonds to roll off the Fed's balance sheet has been quietly working in the background

Starting point is 00:05:26 since June of 2022. Powell asked whether it was contradictory to hold rates steady while reducing the pace of QT, with the suggestion that this could be policy loosening at the margin. He responded, The active tool of monetary policy is, of course, interest rates. This is a plan we've long had in place, not in order to provide accommodation to the economy. It really is to ensure the process of shrinking the balance sheet down to where we want to get it is as smooth and doesn't wind up with financial market turmoil like the last time we did this. Basically, it seems like manipulating the Fed's balance sheet has been abandoned as a policy tool at these levels. The goal seemed to be simply to get the balance sheet down to the desired level without breaking something. Hello, breakers.

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Starting point is 00:06:42 Check out the link to the Bitcoin Ledger Nano in the show notes. 5% of all sales of the Bitcoin Ledger Nano go to support Bitcoin Development. Thanks once again to Ledger for supporting the breakdown. All right, breakers. Consensus 2024 marks the 10th gathering of the biggest event that's devoted to all sides of the crypto, blockchain, and web3 ecosystems. Join pioneering fingers and builders as they delve into the future of defy and explore game-changing tech, from AI to ZK proofs and everything in between. The event is three days of jam-packed content, networking, and so much more. Some of the speakers at the event include Chris Dixon, the founder and managing partner at A16Z Crypto,

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Starting point is 00:08:44 The murmurs have died down now that rate cuts are off the table. But earlier in the year, there was a concern among some that Fed policy could boost Joe Biden's polling. It's also no secret that Powell's working relationship with former President Trump was a little strained at time, to put it mildly. Trump has recently made headlines by suggesting that the president should have final say on rate decisions, a policy that would completely destroy the notion of central bank independence. Powell was asked whether the bar would be higher for cutting rates during an election year. This line of questioning seemed to anger Powell, who responded, We're always going to do what we think the right thing to do is for the economy.

Starting point is 00:09:13 That's our record. That's what we do. We're not looking at anything else. It's hard enough to get the economics right. The September Fed meeting is scheduled to occur seven weeks ahead of the election. When asked whether it would be appropriate to hold off rate cuts into December, Powell answered, there's a significant difference between an institution that takes into account all sorts of political events and one that doesn't. We just don't do that. I can't say it enough that we just don't go down that road. If you go down that road, where do you stop? We're not on that road, we're on the road where we're serving all the American people and making our decisions on the data. As I said at the beginning, overall, the Fed meeting was a fairly sedate affair.

Starting point is 00:09:45 defined by Powell narrowing the paths forward. Powell confirmed market expectations that rate cuts are generally off the table unless a labor market disaster strikes or inflation moderates significantly. He gave no indication of when rate cuts might come back into focus other than suggesting they're not on the agenda until towards the end of this year. The only real point was that slight increases in inflation haven't raised any concerns at the Fed. No action will be taken to renew the inflation fight. The plan is simply to allow current policy to run its course. While Powell has been careful about not declaring victory over inflation, it's clear that the inflation mandate is no longer are being treated as an emergency priority.

Starting point is 00:10:17 Inflation and full employment then are back in balance as dual mandates of equal importance. So net net, until something pushes the Fed to react, no action is the default path. What then was the reaction? Markets saw some relief during the speech, but quickly round-trip the intraday move. Both the NASDAQ and S&P 500 surged up by a couple of percentage points, as Powell began speaking, but ended the day flat. Bitcoin mirrored the move gaining 4.5% before retracing entirely. The only thing that could really explain the price action is that Powell

Starting point is 00:10:44 removed the tail risk of rate hikes, allowing markets a short positive impulse. By the end of trading, it seems the takeaway, though, was that Fed policy is still stuck in the same place it has been for almost a year. Things will need to get significantly better or dramatically worse before rate cuts give markets a reason to move upwards. As for word on the street, the messages were received, but summed up to a fairly neutral event. Michael DePas, the global head of rates at Citadel Security said, Powell made it clear that the hurdle for hikes is incredibly high. They ultimately view the level of rates as being restrictive, that's undeniable. Are they restrictive enough and how long does it take to filter through to the economy are the questions now. Regarding the market move, he said it made

Starting point is 00:11:18 sense that the market is nearing its limits, adding, it has already run out of steam with the market well well off the lows and yield. The market probably struggles to run much more given we are in a place of data dependency. City Group strategists wrote in their research note, the FOMC seemed intent on not letting the market run too far from its base case of solid growth, sticky inflation, and intent to cut later this year. The result was a large round-trip trading day. Edward Harrison, a contributor at Markets Live, wrote, rate cuts before the year is out are still on the table. Takeaway? Rates are capped, but the Fed will ease if the unemployment rate rises much further from here. The Fed has an easing bias. Steve Sosnik, the chief strategist at interactive brokers said,

Starting point is 00:11:53 I was more puzzled trying to figure out what Powell said to make stocks rally so sharply. Sure, he said no hikes are necessary and downplayed fears about stagflation, but that wasn't worth a big speculative rally. I also thought Alex Kruger's take was interesting. He wrote, Perfect FOMC, as doveish as possible. 10 out of 10 given the circumstances. Not yet over, but likely a done deal. Time for the market to focus on another sort of of stress. One potential reason the Fed didn't take a strong stance at this meeting is that most of the meaningful economic decisions are now in the hands of the Treasury. Since the Fed finished hiking rates in July of last year, they really haven't had much to do. Conversely, the most impactful

Starting point is 00:12:27 macro event since then was probably the Treasury quarterly refunding decision last November. Treasury Secretary Janet Yellen made the call to shorten the duration of government debt issuance, which most viewed as providing a liquidity boost to markets. Analysts were anticipating a similar decision this quarter, but the Treasury decided to keep their debt issuance schedule steady. However, the Treasury announced on Wednesday that they would begin buybacks of government debt with the first repurchase schedule for the end of May. The goal is to remove old bonds from the market, providing some marginal liquidity to holders of government debt looking to exit. This should suppress rates a little for longer maturity bonds, but will primarily ensure that there's no risk of dysfunction

Starting point is 00:12:59 in the Treasury market. This is the first time the Treasury has engaged in buybacks since 2002. Analysts noted that this policy decision is happening at the same time the Fed is scheduled to slow down balance sheet runoff, providing liquidity support for multiple angles. markets in mayhem wrote, I don't see the tapering of QT as dovish, as much as a tacit admission that the Treasury market actually needs liquidity support in the form of lower runoff, similar with Yellen's buybacks, not bullish for bonds as much as it is meant to reduce volatility. Macro-analyst Lynn Alden wrote, Treasury buybacks are mostly irrelevant when analyzing the overall liquidity situation, but the fact that the Treasury has to provide liquidity

Starting point is 00:13:31 for what is supposed to be the most deep in liquid market in the world, and that serves as the world's reserve asset is notable. The fact that we're paying attention to how the Treasury is structuring debt issuance at all is deeply strange, and suggest that we've entered into a categorically different macro environment. This is a concept that analysts including Lynn Alden and Luke Gromon have been discussing for several months. They refer to it as fiscal dominance, a period where fiscal policy drowns out the impact of monetary policy to the point of irrelevance. It's odd to see fiscal dominance in developed markets, but it's a frequent occurrence when emerging markets become overburdened with government debt. Interest payments on government

Starting point is 00:14:02 securities become such a large part of the overall economy that changes to Treasury policy can have a meaningful macroeconomic impact. To put some numbers around, it, the U.S. government currently spends around 40% of tax revenue on interest payments on its debt. If this theory is correct and the U.S. has entered fiscal dominance, we could expect to see some strange outcomes moving forward. One of the most bizarre effects that Lynn Alden has been pointing out is that Fed rate hikes could be inflationary. This doesn't happen immediately as the government bonds are issued with a fixed interest rate. But as bonds mature and are reissued at the prevailing rate, interest payments can explode higher, increasing government deficits, and pumping more money into

Starting point is 00:14:34 the system. This obviously limits the usefulness of monetary policy and makes the Fed somewhat impotent. And there's usually not a pleasant end to fiscal dominance, as Lynn points out. Quote, when countries enter fiscal dominance, they almost invariably turn up the capital controls. The goal is to lock money into the domestic economy and then devalue the currency to make the government debt more manageable. You'll sometimes hear this as a plan to inflate away the debt or financial repression. This narrative of fiscal dominance is starting to become more widely accepted as we see more and more signs. And of course, this is exactly the kind of macro conditions that Bitcoiners and before them gold bugs have been warning about. So on the one hand, it is a subtle time,

Starting point is 00:15:07 but on the other a really interesting time. Lots and lots to be paying attention to, which of course we will. For now, though, that is going to do it for today's breakdown. One more big thank you to my sponsor for today's show. Check out the Ledger Orange Bitcoin Nano. 5% of sales will go to support Bitcoin Development. Until next time, be safe and take care of each other. Peace.

The Breakdown - Powell Dismisses Inflation Concerns

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