The Breakdown - Powell Finally Talks Recession

Episode Date: June 24, 2022

This episode is sponsored by Nexo.io, NEAR and FTX US.  For the past two days, Federal Reserve Chairman Jerome Powell has been testifying on the Hill before both committees in the Senate and House. One of the most pointed discussions has been around the possibility that the Fed’s rapid about-face on interest rates and other market support might have the unintended consequence of dropping the economy into a recession.  - Nexo is an all-in-one platform where you can buy crypto with a bank card and earn up to 16% interest on your assets. On the platform you can also swap 300+ market pairs and borrow against your crypto from 0% APR. Sign up at nexo.io by June 30 and receive up to $150 in BTC. - NEAR is a blockchain for a world reimagined. Through simple, secure, and scalable technology, NEAR empowers millions to invent and explore new experiences. Business, creativity, and community are being reimagined for a more sustainable and inclusive future. Find out more at NEAR.org. - FTX US is the safe, regulated way to buy Bitcoin, ETH, SOL and other digital assets. Trade crypto with up to 85% lower fees than top competitors and trade ETH and SOL NFTs with no gas fees and subsidized gas on withdrawals. Sign up at FTX.US today. - “The Breakdown” is written, produced by and features Nathaniel Whittemore aka NLW, with editing by Rob Mitchell, research by Scott Hill and additional production support by Eleanor Pahl. Jared Schwartz is our executive producer and our theme music is “Countdown” by Neon Beach. The music you heard today behind our sponsors is “Catnip” by Famous Cats and “I Don't Know How To Explain It” by Aaron Sprinkle. Image credit: Win McNamee/Getty Images, modified by CoinDesk. Join the discussion at discord.gg/VrKRrfKCz8.

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, near NFTX, and produced and distributed by CoinDesk. What's going on, guys? It is Thursday, June 23rd. And today, we are talking about Fed Chair Jerome Powell, finally, talking about the possibility of a recession. Before we get into that, however, a quick bit of a recession. housekeeping. You can listen to the breakdown in two different ways. You can find the show on the Coin Desk Podcast Network, which comes out every day in the afternoon and features other great shows in addition to the breakdown, or you can listen on the breakdown-only feed, which comes out a few

hours later in the evening. Wherever you listen, if you would be so kind as to leave a five-star rating or even a review, I would so appreciate it. It makes a really big difference, especially when it comes to new people finding the show. Lastly, a disclosure, as always, In addition to them being a sponsor of the show, I also work with FTX. So for most of this week, we have been fairly focused on the crypto side of the house. We looked at what happened this weekend, a crash down and then a rip back up, and whether the relief rally that followed has legs under it or if it was going to run out of steam. By the way, verdict's still out a little bit, but it seems to have run out of some amount of steam at least.

And then we've also discussed whether that 17,000 number that we saw over the weekend was a bottom or whether there are more factors, more pain to come. Yesterday, specifically, we looked at what the impact of minor selling might be. But lurking around the corner in all of this, like the mine flare in stranger things, is the macro context. The context indeed in which all risk assets are falling is the context set by the Federal Reserve. This, of course, is the aggressive unwinding of accommodative monetary policy that has been the norm for the last decade following the global financial crisis. This unwinding is coming in the

form of increased interest rates, but also in the form of quantitative tightening or the removal of liquidity from the financial system. This was hinted at as early as January and actually began in practice this month, with the Federal Reserve allowing certain bonds to run off its balance sheet without replacing them. All of that said, in the last month or so, the discussion within macro has shifted from inflation alone to recession as well and whether the fight against inflation was inevitably going to lead to recession. The concern, of course, has been that a Fed trying to undo its mistakes in not responding to rising inflation sooner might cause an even bigger problem on

the other side. Some have even contended that the Fed needs a recession to get inflation under control, that without it they have no hope. Certainly the unexpected and unwelcome inflation surprise to the upside last month, where we saw an increase to 8.6% inflation, didn't help fears that the Fed doesn't have this one in the bag. Now, the Fed for its part has strenuously denied wanting to cause a recession. Indeed, every time he speaks, Jerome Powell has tended to sidestep the question altogether. Instead, he and the Fed have been focused on projecting a do-what-it-takes attitude,

from the top on down. The regular invocation of Paul Volker, who ripped the federal funds rate up to double digits in the late 1970s, is part and parcel of this positioning. Recently, however, there have been some small indications of, if not a shift in tone, a small opening up, an attempt, perhaps, on the part of the Fed, to give themselves some amount of space to be able to react to changing market conditions without contradicting themselves. This, of course, gets at the point that the Fed's primary and first instrument of moving markets in the direction they want is not actually monetary policy. It's forward-looking guidance about where monetary policy is going to head in the future. Alex Kruger called out the shift a couple days ago, saying there's been a subtle yet widespread

new dovish tone on the Fed's word since last Friday, as so far four out of five Fed officials expressed unexpected dovishness, and so did the Fed's semi-annual report on monetary policy. Here's the list. Number one was from Powell. Fed dual mandate hinges on ensuring financial stability. Number two, Bullard. We don't have as far to go on QT as it might seem. Number three, Keshkari urges caution on, quote, too much front-loading. Number four, Waller, in a recession, there's a good chance need to reduce rate to zero and purchase bonds. It's clear to me that they are trying to remain Max Hockish while quietly opening

the door to pivot in case recession hits and or financial markets collapse. So just to dig into this a little bit more, Kruger is pointing to comments from Powell, where he seems to be emphasizing the financial stability side of the Fed's mandate versus the full employment side, which suggests that they are willing to let unemployment rise if it means an increase in financial stability, i.e. a lowering of inflation. Bullard saying we don't have as far to go on quantitative tightening as it might seem is quite obvious. Trying to hedge and say it's important to do a bit, but it's not like we have to change things radically. Number three, Neil Kashkari, saying too much front-loading could be a problem.

i.e. maybe they don't want to keep going at the 75 basis point hike sort of cycle. And finally, Waller coming out and affirming what markets already think, which is that if we get to recession conditions, easy monetary policy is back on the menu. NXO lets you easily buy crypto with your bank card and earn industry-leading interest rates. Earn up to 16% on crypto and up to 12% on stable coins. Nexo makes passive income easy with interest paid automatically and daily.

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Reimagined your world today at NIR.org. The breakdown is sponsored by FTXUS. FTXUS 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. On Wednesday and Thursday of this week, Jerome Powell was testifying before the Senate and Congress as part of his regular quarterly updates about the economy. First up was testimony before the Senate Banking Committee on Wednesday, and I want to be clear, it's not like his tone changed a ton. I also want to be clear that, yes, it would be nice to live in a world where markets didn't live and breathe and psychoanalyze every word this dude said, but here we are. With those caveats aside, Powell's tone did shift a bit in meaningful ways. For the sake of history, in his last appearance on Capitol Hill on March 2, just a few days,

remember after Russia invaded Ukraine, Powell said, quote, I think it's more likely than not that we can achieve what we call a soft landing. A soft landing in this case, as you know, means being able to fight inflation without causing a recession. This time, not only did Powell not use the term soft landing ever, there was more of an acceptance that the circumstances of reality had changed. He did what he never really did with the transitory inflation phraseology, which is admit that bad things might actually happen as consequence of their policy. The Bloomberg headline after Powell spoke, Blair, Powell says soft landing, quote, very challenging, recession possible.

Basically, from Powell yesterday, we got the most explicit acknowledgement yet that interest rate policies could tip the economy into a recession. However, this was still presented as a low chance. And what was clear is that Powell and the Fed did not see this, at least as yet, as a reason to change course. In fact, he said, quote, the other risk, though, is that we would not manage to restore price stability, and that we would allow this high inflation to get entrenched in the economy. We can't fail on that task.

We have to get back to 2% inflation. As part of this, he said that it would be appropriate to keep hiking rates in coming meetings. Though he didn't mention numbers in his testimony, with reporters later, he said that another 75 basis point or 50 basis point hike was on the table for the next meeting. Market commentators for their part have moved pretty firmly into recession is coming mode. Economists surveyed by the Wall Street Journal saw a 44% likelihood of a U.S. recession in the next 12 months. That's a level that tends not to be seen except when we're actually on the brink of a recession historically. Also on Wednesday, former Fed Bank of New York President and Vice Chairman of the FOMC, Bill Dudley,

wrote an op-ed called the U.S. economy is headed for a hard landing. A recession is coming within 12 to 18 months as the Fed focuses on curbing inflation. Interestingly, this piece also noted recent changes in the Fed's tune. First, it called out that while full employment is the Fed's other mandate, recent appearances from Powell had cut out language that the labor market would remain strong even as the fight against inflation took hold, suggesting that the Fed is willing to accept some casualties on the job front if it means inflation comes under control. Second, Dudley points to fear of expectations of inflation becoming entrenched and requiring or causing an even bigger recession later.

He writes, from a risk management perspective, better to act now whatever the cost in terms of jobs and growth. Powell does not want to repeat the mistakes of the late 1960s and the 1970s. Finally, Dudley wrote about how this particular economy is quite susceptible to a sudden stop. This you might call the Wiley-Coyote theory of the economy. Effectively Dudley is saying that the set of factors that have kept growth going, including payroll growth, reopening, and healthy balance sheets supported by 2020 and 2021 fiscal stimulus, all have the potential to keep demand high for some period, but when it stops, the shift is likely to be quite abrupt. At some point, in other words, that fiscal stimulus will run out and demand will stop,

and that's the moment when Wiley Coyote, already far out off the cliff and over the nothing, finally begins to fall. Now, there are some worrying signs on that front. As inflation has continued to outstrip wage growth, the personal savings rate has absolutely cratered. It was at 26.6% in March 21 and 4.4% this April. While 26.6% was elevated coming off of all of that stimulus, 4.4% is significantly below its long-term average.

Consumer sentiment is at lows we haven't seen since just after, the 2008 financial crisis and Google searches for the word recession are achieving new records. Rightly or wrongly, the media is also feeding into this. The front page of Bloomberg is already blaring headlines like, what you need to know about recessions, including whether we're in one, and how to make money in a recession. Now, of course, as weird as it sounds, there is a bright spot for some investors. Many are viewing the risk of a recession as a somewhat positive sign for markets, as they believe it will force Powell and the Fed to reduce rates again. After Powell's first set of comments, remember he testifies again today, this time in front of Congress,

money markets indicated decreasing odds that the Fed will continue to raise rates after the end of this year, as well as rising odds of a rate cut sometime from May of next year and beyond. Now, before we leave Powell one more crypto-specific note. Three senators including Cynthia Lummus, Senator Kirsten Sinema, and Senator Sherrod Brown, all put questions on crypto to Powell around things like regulation, the accounting treatment of digital assets, and the current crash. Powell gave what has become his standard answer on this front, which is effectively that they are, quote, tracking those events very carefully, but also, quote, not really seeing significant macro implications so far. In other words, this isn't my problem yet. Don't make me deal

with it right now. His other Pat line was highlighting a need for a better regulatory framework. Quote, the same activity should have the same regulation no matter where it appears, and that isn't the case right now, because a lot of the digital finance products in some way are quite similar to products that have existed in the banking system or the capital markets, but they're just not regulated the same way. So we need to do that. Anyways, if you were hoping for more of a sign on what Powell thinks on crypto, unfortunately, you didn't get much yesterday. Lastly, before we wrap up, I just did want to mention that a lot of these stories and through lines from the macroeconomic perspective are global, even though we cover the U.S. most on the show. At the beginning of this week,

the British Office of National Statistics said that inflation hit a high of 9.1% in May, which was up slightly from April and the highest number in 40 years. Food prices and record high gasoline were the biggest culprits, and importantly, the Bank of England has said that inflation could hit 11% by October. Right now, energy is artificially cheap because of a cap on domestic energy costs. And of course, the difference in the UK is that, like the rest of Europe, they're even more impacted by Russia's war in Ukraine. Right now, the big challenge. for policymakers in the UK is to not let the supply-side shock of energy and food prices inflame a wage price spiral that seems to be on the horizon as workers are already pushing

hard to see pay increases. Right now, tens of thousands of railway workers in the UK are walking off the job for three days, which is the biggest transit strike for three decades. Things are not going well in Europe either. One indicator for economic activity in Europe fell to a 16-month low. Manufacturing output declined for the first time in two years. And one concerning thing here, going back to this Wiley-Coyote vision of the economy, is that Europe is suggesting to us right now that that leftover post-pandemic demand is going to dry up fast. S&P global economist Chris Williamson said, quote, economic growth is showing signs of faltering as the tailwind of pent-up demand from the pandemic is already fading, having been upset by the cost of living shock and slumping business and

consumer confidence. This might be why hedge funds like Bridgewater are making huge bets against European stocks. Radalio's firm currently has $10.5 billion in short positions against 28 European firms, the fund's most bearish stance against Europe in two years. When we've been discussing whether we've found a crypto bottom over the last couple days, the big and obvious reason that makes it so hard to get comfortable with that idea is everything we've been talking about today and just how unstable and unsettled it still is. War and conflict in Europe aren't over. Inflation not only isn't over, it seems to be going up. Central banks are desperately trying to raise and convey hawkishness, even as the reality of recession gets closer and closer. It's hard to imagine a risky asset like

crypto, finding a bottom in that sort of unsettled circumstance. But of course, I hope I'm wrong. For now, I want to say thanks again to my sponsors, nexo.com. I know. NIR and FTCX. and thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace.