The Breakdown - Powell Says No Rate Cuts in March

Episode Date: February 2, 2024

NLW breaks down the first FOMC meeting of the year. Enjoying this content? SUBSCRIBE to the Podcast: https://pod.link/1438693620 Watch on YouTube: https://www.youtube.com/nathanielwhittemorecrypto Subscribe to the newsletter: https://breakdown.beehiiv.com/ Join the discussion: https://discord.gg/VrKRrfKCz8 Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW

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, February 1st, and today we are talking about 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. Breakdown Pod. Hello, friends, back with a macro check-in day, and the long and short of it was that the first FOMC meeting of the year was marked by uncertainty and a lack of confidence. So, the Federal

Reserve held policy rates steady on Wednesday, no surprise there, with Jerome Powell explaining that he wants to see more convincing evidence of low inflation before starting rate cuts. The last six months of data have shown short-term inflation at the 2% level accompanied by strong growth. markets have been pricing in a rate cut cycle to begin in March, with as many as seven rate cuts this year. But the current amount of data just wasn't enough for the Fed to feel confident that inflation is over. Powell explained that decreasing inflation without declines in growth or the labor market gives the Fed the luxury of looking at more data before making the call to start cutting rates. He said,

It is a highly consequential decision to start the process of dialing back restriction, and we want to get that right. We feel like the strong economy, strong labor market, and inflation coming down gives us the ability to do that. Now, the focus was clearly on the medium term. Powell was not comfortable to lock in rate cuts for March, only to see another wave of inflation pick up. He said, we've made a lot of progress on inflation. We just want to make sure that we do get the job done in a sustainable way. Powell explained the balance of risks faced by the Fed at the current moment. Cutting too much or too early, quote, could result in a reversal of the progress we've seen on inflation and ultimately require even tighter policy

to get it back to 2%. On the other hand, waiting too long could, quote, unduly weaken economic activity and employment. That was the official view of the committee articulated through their statement. But throughout media questioning, Powell was clearly more worried about the risks of cutting too aggressively. He said, in the base case where the economy is healthy, we think we can and should take advantage of that and be careful as we approach the question of when to dial back restrictions. Ultimately, Powell volunteered that a rate cut in March is probably not on the table, saying, based on the meeting today, I would tell you that I don't think it's likely that the committee would reach a level of confidence by the time of the March meeting to identify March as the

time to do that. I don't think that's the most likely case. Indeed, the big theme of the press conference was confidence. Over and over, Powell said the committee wanted to have confidence that inflation was sustainably heading back down to 2% before they cut rates. He said, It's not that the six-month data isn't low enough. It is. It's just a question of, can we take that with confidence that we're moving sustainably under 2%. Powell noted that over the past six months, supply chain improvement has led to disinflationary goods pricing. Coupled with a recovery and labor force participation and strong migration, this has created an economy with strong growth and low inflation. Powell just isn't convinced this is a pathway to consistent

2% inflation, stating, we're not declaring victory at all at this point. We think we have a ways to go. Now, Powell was not saying that his base case is for another wave of inflation to show up, just that he needs to be convinced that inflation is truly over. He said, You've had six very good months, but what's really going to shake out here? Will inflation have dipped and then come back up? Are the last six months flattened by one-off factors that won't repeat themselves? We don't think so, but that's the questions we have to ask, and we want to get comfort with that. Now, one of the key pieces of economic data to come in well above expectations over recent months was GDP growth. The first estimate for Q4 GDP came in at an annualized rate

of 3.3% last week, blowing past the consensus forecast of 2%. A prevailing recent question has been why the Fed would need to cut rates while growth remains strong. This question was put to Powell, with the suggestion that policy easing into strong growth could risk inflation. He shrugged off hot growth as a risk factor, noting that the distorted pandemic economy has confounded forecasters ever since. Powell said, We've had inflation come down without a slow economy and without increases in unemployment. There's no reason we should want to get in the way of that process if it's going to continue. He added that, we don't have a growth mandate. We have a full employment and a price stability mandate. Growth only matters to the extent it influences our achievement of those two mandates.

Regarding downside risks, Powell discussed anecdotal data gathered by regional feds, which is co-related into a document known as the beige book. He acknowledged that the previous beige book has been filled with stories of declining economic activity, but this time around, things seemed less dire. What you're hearing now, he said, is that things are picking up a bit. Not every district and not every person that we talk to, but overall, you're hearing about things picking up at the margin. Now, let's contrast this with December's FOMC meeting. At that meeting, his tone was very entirely different. The Fed's dovish dot plot had given market participants permission to start thinking seriously about rate cuts this year. When he had the opportunity to dial this expectation

back, Powell declined. That was a move which was viewed as extremely doveish and allowed the stock market to get ahead of rate cuts. At this meeting, Powell explained that while the Fed thinks that rate cuts are coming, they aren't certain when to begin. He said, almost every participant on the committee does believe that it will be appropriate to reduce rates. What we're trying to do is identify a place where we're really confident, there's that word again, about inflation getting back down to 2%, so that we can then begin the process of dialing back the restrictive level. Powell reinforced that the Fed is currently taking things meeting by meeting and is heavily data dependent. He was also asked about the risk of holding rates too high as inflation moderates,

creating unnecessary tightening. He clarified that the Fed is watching the data closely for signs of both inflation and recession risk, standing ready to act as necessary. And although Powell isn't looking to cut rates soon, he said that doesn't mean that we wait around to see the economy turned down because that would be too late. We're really in risk management mode, of managing the risk that we move too soon or too late. Now, a popular narrative, which emerged from the last meeting, was that the Fed, and by extension, Powell, might be considering cutting rates to give the economy a boost in an inflation year. Despite being a Republican appointee, it's no secret that Powell's relationship with former President Trump was at times adversarial. Powell was asked about recent

comments from Republican presidential candidates, indicating that he was unlikely to be considered for a third term as Fed chairman. When asked if he was interested in seeking an additional term, Powell said, I don't have a stance on that. It's not something I'm focused on. I'm focused on doing our jobs. This year is going to be a highly consequential year for monetary policy, and all of us buckled down and focused on doing our jobs. Now, the Fed has also been facing pressure from the left recently. On Monday, a group of Democrats led by Elizabeth Warren wrote to Powell insisting that he cut interest rates to ease pressure on housing costs. This person and her letters, oh my goodness. Now, leaving aside the wisdom of the policy suggestion, the letter had clearly made an impact

on Powell. When asked about it, he made a broader point about the Fed's role, stating, the job Congress has given us is price stability and maximum employment. Price stability is absolutely essential for people's lives, mostly for people at the lower end of the income spectrum who are living at the edges. For someone like that, high inflation and the necessities of life, right away you're in trouble, whereas even middle class people have some scope to absorb higher costs. It's our job what society has asked us to do is get inflation down. The tools we use for that are interest rates. That's how we think about that. This notion that the Fed had a responsibility to bring down inflation to ease pressure on lower

income households came through in multiple additional comments from Powell as well. Today's episode is brought to you by Cracken. For far too long, the whole financial system has been standing still, too slow, only on for certain hours. overly designed for some types of people, but not for others. Crypto, at its best, represents progress. It asks the question, what if? It invites people in instead of leaving them out. It's on 24-7, 365, and moves at the speed of real life.

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PVI, BVI, DBA, Cracken. Now, one of the other hot topics in financial circles over the past month has been quantitative tightening, and specifically when the Fed would choose to slow down their balance sheet reduction program. QT has been largely running on autopilot in the background since June of 2022, lowering the Fed's balance sheet by $1.3 trillion. The reason QT is getting attention right now is that the reverse repo facility, which stores excess liquidity from banks and money market funds, has been drawn down by 70% over the past six months. Many are concerned that once reverse repo hits zero, it will unleash QT at full force and trigger a liquidity crisis. Powell said that the FOMC

had not discussed QT in any great detail at this meeting, but that it was on the agenda, stating, we're planning to begin in-depth discussions of balance sheet issues in March. Those questions are all coming into scope now, and we're beginning to focus on them. He explained that the Fed views the balance sheet and interest rates as two separate tools, so it would be comfortable operating them independently. Speaking more broadly, Powell said that the medium-term goal was policy normalization. That might require rates to be lowered while the balance sheet continues to be reduced, to bring both to more normal levels. Under normal monetary policy theory, this would be viewed as

tightening and loosening at the same time, but this logic has been the subject of debate. The big point ultimately was that the Fed has its eye on the reverse repo facility drawdown, but Powell won't commit to when QT would be slowed down in relation to the facility. Now, really the big takeaway from all of this was the same thing that we've seen before, but really reinforced, especially after being absent last time, which was that Powell does not want to give inflation any opportunity to roar back to life. New York Times economics reporter Ben Castleman wrote, My take on this after listening back through again,

I think Powell planned to throw cold water on March, but expected someone to ask about it more directly than they did, and then found himself halfway through the presser looking for an opportunity to slip it in. Bloomberg columnist Connor Sen wrote, My guess is Powell's using the growth data and market performance in January to gamble that he can afford to wait an extra six weeks to buy goodwill with the hawks, tempting fate a bit. Nick Timrose from the Wall Street Journal wrote,

the Federal Reserve signaled that it is well into the when to cut phase of interest rate policy deliberations. But Chair J. Powell also dropped a not so subtle hint that the answer is probably not March and less economic activity were to weaken notably. So what was the market response to all this? Well, they appeared to be relatively happy with the rate decision, getting a slight boost in the early stages of the press conference. That all changed half an hour in, when Powell finally took March cuts off the table. Until that stage, Powell had been talking about the issue, expressing that the Fed would need more confidence in declining inflation, but not explicitly addressing the March meeting. Once rate cuts were pushed back by at least six weeks, markets kind of plunged.

The S&P sold off hard, ending the day down 1.6%. The NASDAQ followed the same pattern slipping by 2.2%. Bitcoin taking its cues from something other than ETF flows for the first time in a few weeks, also traded down 2.2% from its peak. Fed Fund futures markets responded immediately to Powell's comment, repricing the chance of a March rate cut from 60% all the way down to 35%. Wall Street analysts have been pushing hard for rate cuts, so this meeting no doubt disappointed many. Goldman Sachs put out a note to say that they still expect five rate cuts this year and another three next year, although they push their expectation for the first rate cut out to May in deference to Powell's comments.

DeLeep Singh, a New York Fed official who is now chief global economist at PGM fixed income, said, the current stance of policy is no longer warranted by the inflation backdrop. The prudent policy stance is to return to a neutral setting. There are potentially serious costs and little benefit to waiting. The longer they wait, the larger the risks will grow. Others were a little more focused on the longer term, recognizing that pushing rate cuts back won't be a problem. Camarica Bank's chief economist Bill Adams wrote in a note, the Fed was badly burned in late 2021 and 2022, when they thought high inflation would be transitory, then got caught by surprise when it was higher and more persistent than expected.

They want to avoid making the same mistake twice. The Fed will wait to pull the trigger on rate cuts until they see the whites of 2% inflation's eyes. David Zervos, Jeffrey's chief market strategist, identify the policy space which has now been carved out by the Fed, even if we need to wait a few more months for rate cuts. He wrote, the Fed put is back. Not a matter of will, but the fact is they can if things get messy. Ultimately, growth and earnings are going to have a more important impact than the Fed. They are no longer the most important storyline. Now, one of the sub-thoughts of Wednesday's meeting was the morning price action in regional bank stocks. New York Community Bank Corp had reported dismal earnings the previous night, which is of course the bank that absorbed signature bank after

its demise in March of last year. This added even more commercial real estate exposure to its books, and the bank reported a net loss of $260 million rather than the similarly sized profit, which had been forecast. It also marked down a $552 million provision for loan losses and slash dividends by two-thirds. The company sold off by 40% at the open, and a group of eight similarly positioned regional banks dropped between 3% and 6% alongside. Many posted their largest drawdown since last March. Now, analysts were quick to suggest that problems at NYCB were a little different to last year's banking crisis. Former Fed Governor Betsy Duke said, this appears to be not a capital issue, but really an issue of loan quality. An issue in credit is a bit slower moving than a liquidity issue.

She pointed out that NYCB is a very large mid-sized bank and will be under intense regulatory scrutiny. Although a bank run would be required to cause a problem, last year demonstrated that a credit issue can turn into a liquidity issue almost overnight. Now, the morning, parents, over NYCB didn't end up rating a mention in Powell's press conference. There wasn't even a discussion of the bank term funding program which is set to be shut down in March. The BTFP was set up in a hurry last year to provide emergency liquidity to regional banks, and many are concerned its closure will put the pressure back on. The only hint of reference at the FOMC was the quiet removal of one paragraph from the official Fed statement. Most of the paragraph referred to tighter financial

conditions weighing on economic activity and inflation, something which is clearly less important now. The first sentence that was removed, however, read, the U.S. banking system is sound and resilient. So, folks, there you have it. We are clearly in an in-between moment. We are no longer in a tightening period, but not yet at a loosening period. And everyone is just antsy in this muddy middle. But things could be a lot worse, and I'm sure markets will digest that pretty soon. For now, that is going to do it for today's breakdown. One more big thank you to my sponsor for today's show, Cracken. Go to crackin.com and see what crypto can be. Until next time, be safe and take care of each other. Peace.