The Breakdown - Powell: “How Little We Understand About Inflation”

Episode Date: July 2, 2022

This episode is sponsored by Nexo.io, Chainalysis and FTX US.    On today’s episode, NLW looks at:  Fed Chair Jerome Powell’s comments on inflation at the ECB conference. The latest recession indicators.  Manufacturing declines.  Turmoil in the housing market. And more!    - Nexo is a security-first platform where you can buy, exchange and borrow against your crypto. The company safeguards your crypto by relying on five key fundamentals including real-time auditing and insurance on custodial assets. Learn more at nexo.io. - Chainalysis is the blockchain data platform. We provide data, software, services and research to government agencies, exchanges, financial institutions and insurance and cybersecurity companies. Our data powers investigation, compliance and market intelligence software that has been used to solve some of the world’s most high-profile criminal cases. For more information, visit www.chainalysis.com. - 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 and research by Scott Hill. Jared Schwartz is our executive producer and our theme music is “Countdown” by Neon Beach. The music you heard today behind our sponsors is “TheNow ” by Aaron Sprinkle. Image credit: Horacio Villalobos#Corbis/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.com, and FTCS, and produced and distributed by CoinDesk. What's going on, guys? It is Friday, July 1st, and today we are talking about Fed Chair Jerome Powell's assertion, about how little we understand inflation. First up, however, a quick note about the show. There are two ways to listen to the Breakdown podcast. You can find it on the Coin Desk Podcast Network feed, which comes out every afternoon and also features other shows besides the breakdown,

or you can listen on the Breakdown-only feed every evening a few hours later. Wherever you are listening, I would so appreciate if you would go leave a rating and a review, it makes a big difference. Lastly, a disclosure as always. In addition to them being a sponsor of the show, I also work with FTX. So welcome to July, everyone. It is a new month, historically one that is a bit calmer for markets, where we can step away, touch grass, go to the ocean, eat a lobster roll, but not right now. Oh, no, the summer sun isn't the only thing hot right now. We have defaults, failures, crashes,

crypto-contagion, and of course, all of it is set to the beautiful backdrop of the macro. Today we're going to catch up on everything that has happened on the macro side of the house over the last week, and I think that the only appropriate way is to start with a beautiful infographic published by the one and only Kobe. The infographic is a set of quotes, assertion, statements from Fed Chair Jerome Powell, organized by their quarter. In Q121, he says, QE won't cause inflation. In Q221, he says, some inflation, but transitory. Q321, okay, high inflation. but we are peaking. Q421. Okay, inflation may not be transitory, but job market wage growth very strong.

Q1.22, need to hike aggressively to curb inflation, but no worries. Economy very strong and soft landing possible. Q222, negative growth in Q1, but no recession risk. Q322, okay, recession coming, but you will not lose your home. Q422, okay, you may lose your home, but you won't starve to death. Q1.23, you may die, but you go to heaven. So let's start with Mr. Powell. Earlier this week, he spoke at the European Central Bank's annual economic policy conference. The backdrop, of course, is the most aggressive pace of rising interest rates since the 1980s, surrounded by the fear that higher prices will change consumer psychology,

in other words, making further inflation a self-fulfilling prophecy. Powell has recently shifted away from his language of, we're not trying to cause a recession, to language of, we're not trying, but even if we do have a recession, it's not as bad as permanent higher inflation would be. At the ECB conference, he really reinforced this message saying there's a clock running here. The risk is that because of the multiplicity of shocks, you start to transition into a higher inflation regime. Our job is literally to prevent that from happening, and we will prevent that from happening. Speaking of a soft landing or being able to

bring down inflation without recession, he also said, there's no guarantee of a more benign outcome. It has gotten harder. The pathways have gotten narrower. The process is highly likely to involve some pain. But the worst pain would be in failing to address this high inflation and allowing it to become persistent. One of the new things that we're seeing from central bankers is the language of we're never going back to the before times. Christine Lagarde, the head of the ECB, said, I don't think we're going to go back to that environment of low inflation. And then Powell hit them with the quote that everybody has been talking about. Given how badly central banks everywhere had done at forecasting inflation over the past year, and pressed on whether they had a better understanding now of

price-setting dynamics, Powell said, we now understand better how little we understand about inflation. The Bloomberg host asking questions said that sounds very reassuring, and Powell replied, no, honestly, this was unpredictable. Now, of course, everyone on Twitter from Anon's on down said it was unpredictable, seemingly only to experts versus everyone who is shouting about inflation being here for months. Now, let's be clear. I've said before, and I totally stand by the assertion, that I would rather have public officials admit when forces that they don't fully understand or shaping what they're trying to make policy around rather than make up some cockamamie language that traps them, i.e. transitory inflation. And yet, and yet, perhaps, if Powell and the Fed had not

committed so aggressively to the arrogant assertion that we did understand the inflation coming off of COVID, we would have had more time to figure out that something fundamentally different was going on. The Fed might have had time to set policies to shift policies that could have eased things before they got truly out of hand. But they didn't, and here we are. So let's move on to what's actually happening in the real economy. A delightful little official update from this week is that the U.S. GDP shrank 1.6% in Q1 on an annualized basis. And, as MarketWatch puts it, the second quarter isn't looking all that great either. Now, I do think that as we discuss GDP, it's important to note that it's more complex than it first appears. For example, in Q1,

there was a record surge in the U.S. trade deficit, while consumer spending and business investment still both rose. That said, Q1 was a long time ago, and there are some concerning signals. The Atlanta Fed's GDP tracker sees the second quarter running at negative 1% as of now. Two quarters in a row of negative GDP growth equals a technical recession. Now, technical recession sounds like the type of term that politicians would foist upon us, like transitory, as a way of making something that is bad seem less bad, but in this case, I think that this matters. One of the big things about what happens during recessions is that in addition to negative growth,

there tends to be a contraction in the labor market. In fact, it's quite rare for there to be growth contractions without associated big layoff periods. In the modern era, there have only been a few times that this has happened. This contributes to what can be a fairly vicious loop. Layoffs lead to income reduction, which leads to collapse in growth, which of course leads to further layoffs, which leads to more income reduction, which leads to further collapses in growth. You get the point and you see how the cycle plays out.

However, we're in an extremely tight labor market right now. What's more, the perception of the labor market has been extremely tight for companies for some time. That perception might mean that they're not as willing to lay off people because they're attempting to preserve already hard to come by human capital. So far, the layoffs that we've seen are primarily in previously way overheated areas of the economy that are finally starting to unwind, namely in tech and in mortgages and housing. Of course, this isn't to say that even a technical recession without mass layoffs is a good thing, thing, but just an attempt to be actually clear about what we're dealing with here.

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There are no fixed minimum fees, no ACH transaction fees, and no withdrawal fees. One of the largest exchanges in the US. FDXUS is also the only leading exchange that supports both Ethereum, and Solana NFTs. When you trade NFTs on FTX, you pay no gas fees. Download the FTX app today and use referral code breakdown to support the show. As ever, the talking heads peddle all the takes.

Former Treasury Secretary Larry Summers, who at this point seems like his only job is to keep himself quoted by Bloomberg, was quoted by Bloomberg as saying, the risks of a 2022 recession are significantly higher than I would have judged six or nine weeks ago. If the economy did go into recession in the next six to nine months, then you'd probably see a reduction in inflationary pressures. The question, of course, here is implications for the Fed. Zero hedge is screaming, saying that bond markets are pricing in 10 basis points of rate cuts in the first quarter of next year based on these recession expectations. They tweeted, the Jackson Hole Dovish pivot will be glorious. Now, what they're referring to is the annual Fed conference held in Jackson Hole, Wyoming, where the Federal Reserve

tends to telegraph big changes in their thinking. That happens at the end of all. August. Zero hedge could be right, but from my vantage point, it seems like they're at least preparing themselves narratively for the reverse to be true. The Fed is ramping up louder and louder its arguments for why, recession or not, it shouldn't shift course on inflation. Bringing it back to right now, the week ended with another down signal, this time in U.S. manufacturing. The Institute for Supply Management gauges manufacturing activity and its measure hit a two-year low in June based on new orders contracting because of supply constraints and a softening in demand. The other story the number told was of inventories growing,

suggesting again weakening demand as consumers adapt to higher inflation and a higher overall cost of living. Data also showed at the end of this week that consumer spending fell in May for the first time in 2022. Basically, people are buying less stuff as this new economic reality sets in. Honestly, the new economic reality settling in could be the title of this show. Just a quick survey of the Bloomberg homepage shows how many areas in which this is true. On the breakdown, we've been keeping track of the craziness in the home market. A month or two ago, we looked at why markets had gotten so absurd in the first place, with prices going up incessantly.

TLDR, it started with construction shortages that came after the global financial crisis. At this point, though, the rise in interest rates has firmly set in and changed things. Lenders have been laying off mortgage professionals. New mortgages and refies are way down. Today, Bloomberg published a piece, Home Sellers are slashing prices in sudden halt to pandemic boom. quote, the pandemic housing boom is careening to a halt as the fastest rising mortgage rates in at least half a century, upend affordability for homebuyers, catching many sellers wrong-footed with prices

that are too high. It's an astonishing turnaround. Just a few months ago, house hunters felt pushed to make offers within days, wave inspections, and bid way above asking. Now they can sleep on it and maybe even shop for a better deal. End quote. Another interesting data point is that sellers seem to be trying to race to catch an opportunity. Home listings are still low by historical standards, but increased at their fastest pace since 2017 in June. That reads to me like people are trying to catch the last good markets before even further price declines hit what they would have wanted to sell. Listings in some of the previously hottest areas like Austin, Phoenix, and Vegas have seen approximately one-third of June listings

have price cuts. Now, one part of this is, of course, the significantly increased cost of borrowing, but the other part is the inherent concern around recession. In the understatement of the Century Bloomberg writes, stock market turmoil and recession fears do little for buyer confidence. Now, the real question, of course, going back to Kobe's chart from the beginning of this show, is how likely people are to lose their homes. The news there is perhaps a little bit better. Between May 2020 and May 2022, U.S. single-family home prices jumped about 45%, easily the biggest two-year increase on record. That means that even if people do lose their jobs, they're unlikely to have to sell at a loss. What's more, this boom in housing prices was caused by historically low interest rates, causing

historically low mortgage rates, meeting historically low supply. And while that has significant consequences as we're seeing now, it's very different than risky lending such as subprime lending which caused the last housing crisis. A bigger concern might be implications for the rental markets. With people now being priced out of borrowing, instead of just priced out of the cost of homes, it could keep more people in or even push more people towards renting, which could make rental prices less affordable. Now, as we turn towards the conclusion of this show, quicker hits suggest that this idea of expectations resetting really is everywhere. Spacks are being canceled faster than you can spell Chimoth. At least four of these deals have been called off in the last couple of days, making a total

of 30 SPAC cancellations this year. Some of the companies that are backing off include Panera brands and E. Toro, the online brokerage. This is not surprising if you look at the DSPAC index, which is a basket of post-spac companies, and see that it's down 68% on the year. Layoffs and tech also continue. Meta slashed its engineer hiring goal by at least 30%, with Mark Zuckerberg telling employees that he's anticipating, quote, one of the worst downturns that we've seen in recent history. Now, keep in mind, they're still planning on hiring,

like 6,000 to 7,000 people instead of 10,000, but it's still a big shift. What's more, the 77,800 people that work for Meta currently might not be safe either. Zuckerberg also said, realistically, there are a bunch of people at the company who shouldn't be here. Part of my hope by raising expectations and having more aggressive goals and just kind of turning up the heat a little bit is that I think some of you might decide that this place isn't for you, and that self-selection is okay with me.

This to me is a big fat LOL. We've been seeing a lot of this lately. CEOs talking a big game about how the company needs to be one way or another, and if you don't like that, well, you're free to go, which is fine and could be sincere and could be good for the company. Or it could be a way to get out of having to actually select and fire people and pay severance. In any case, meta-stock price is down 52% on the year. I have no doubts that will soon see U.S. politicians bemoaning the pensioners whose savings are halved, investing in one of the most prominent public equities in the United States.

Finally, to close, let's look at travel. Since its 4th of July weekend, there is a lot of travel going on. 12.3 million people are expected to fly between June 30th and July 4th, which is about 8% more than Memorial Day weekend, which is the summer kickoff. Over Memorial Day weekend, more than 21, 1,000 flights to and from the U.S. were canceled or delayed, and meanwhile, the average price of domestic fare sits at 437 per round trip, the highest number in five years. Over the last month or so, 2.7% of flights of the biggest airlines were nixed, nearly 14,000 flights canceled. More than 25%

over 126,000 were delayed for an average of 50 minutes. That means 14 million travelers were affected by this over the past five weeks. That's compared to 1.7% canceled and 19.4% delayed pre-pandemend There has also been a 15% increase in passenger complaints, and in terms of who to blame, it is a real Spider-Man pointing at Spider-Man meme over here. It's shortages in air traffic controllers, it's poor scheduling by airlines, everyone is blaming everyone, but airline stocks so far aren't too hampered, mostly because it's not like people who are traveling have a lot of options. So that is the macro view from here.

It is a lot more of the same, but seemingly a lot more to come as well. For now, I want to say thanks again to my sponsors, nexo.io, a new sponsor in Chainalysis and FTX. Lastly, a big thank you to NIR, who has been a great sponsor over the past couple months. And finally, a big thank you to you guys for listening. Until tomorrow, be safe and take care of each other. Peace.