The Breakdown - Powell Signals Rate Cuts Finally Coming in September

Episode Date: August 1, 2024

At yesterday's FOMC, the Fed held rates steady but Powell signaled a September cut to come. Still he left himself characteristic wiggle room. NLW covers it all on this macro focused episode. 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, August 1st, and today, of course, we are catching up on the FOMC meeting. 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. Well, friends, the July FOMC meeting saw the Fed hold rates steady, but they appear to be right on the precipice of delivering their first rate cut. If no surprises show up in economic data, Jerome Powell said, quote, a rate cut could be on the

table at the September meeting. There was a sense that the tone has shifted right from the start of the day. The policy statement, which is released ahead of the press conference, had a number of significant changes compared to last month. A moderation in job gains was acknowledged for the first time, as was an increase in unemployment. A reference to being highly attentive to inflation risks was removed in favor of framing the FOMC as, quote, attentive to the risks of both sides of its dual mandate. Powell continued this theme into the press conference describing everything in terms of the balance of risks. He said,

We know that reducing policy restraint too soon or too much could result in a reversal of the progress we have seen on inflation. At the same time, reducing policy restraint to later too little could unduly weaken economic activity and employment. Powell was careful to emphasize that policy decisions are still being made, meeting by meeting, in a data-dependent manner. However, the was on the Fed being well positioned to respond to an unexpected weakening in the labor market or rapidly falling inflation. Once the floor was open to the media, there was only one question on anyone's mind. Will the Fed cut at the next meeting in September? Given that a September cut is fully priced in and the FOMC seems to believe that's a reasonable expectation, Powell

was asked why they wouldn't just start cuts now. In response, he gave detailed overview on how the FMC is thinking. He said, the broad sense of the committee is that the economy is moving closer to the point at which it will be appropriate to reduce our policy rate. In that, we will be data dependent but not data point dependent. The question will be whether the totality of the data, the evolving outlook and the balance of risks, are consistent with rising confidence on inflation and maintaining a solid labor market. If that test is met, a reduction in our policy rate could be on the table as soon as the next meeting in September. As for why cuts couldn't have happened at this meeting, he said that while the committee is approaching the point where it's appropriate to cut

rates were, quote, not quite at that point yet. The second question attempted to pin down on firm guidance for September, asking whether a rate cut is now the baseline expectation. Powell responded by giving a detailed summary of the Fed's current reaction function. He said that if inflation, growth, and unemployment continue to play out as they have over the previous quarter, then a cut is on the table. His only caveat was that if the data shows stickier than expected inflation. In that case, it wasn't even that a rate cut would be out of the question. That data would simply be weighed against labor market numbers. This was the general theme of the press conference. would walk right up to the line of committing to rate cuts at the next meeting, but refused to

actually give solid guidance all the way. He couldn't even give additional detail on how many rate cuts should be expected this year. He gave the vague answer that there are scenarios where it would be appropriate to do, quote, everywhere from zero cuts to several cuts, depending on the way the economy evolves. It wasn't even clear in Powell's mind that this was the beginning of a cutting cycle that would normalize rates. He said, the thing we're trying to do, we've had this really significant decline in inflation and unemployment has remained low. This is historically unusual and such a welcome outcome for the people we serve. What we're thinking about all the time is, how do we keep this going? The only thing that clearly wasn't on the table at this point was a 50 basis point cut in September.

There was a sense that the FOMC had decided not to give ironclad guidance with Powell stating, I wouldn't want to lay out a baseline path for you. I've said what I can say about September today, though. Much later in the press conference, Powell was asked whether there is a general sense of confidence that there could be a rate cut in September. He blurted out yes before the question could even finish. And this gives you a sense of how the whole thing felt. Powell has finally made it clear that he was willing to say that this is probably happening. He wasn't willing to say anymore, even in spite of every reporter there trying to get him to say more. Now, discussions of inflation risk were almost entirely absent. When asked whether inflation could return, Powell was pretty

clear that he just doesn't see it in the data. He explained that the last quarter of disinflation has been broad-based compared to last year, which was largely driven by an unsustainable disinflation in goods prices. Still, he emphasized that this was only one corner, so the committee wants to see a few more months of data to be sure. One of the reasons inflation risk has fallen is moderation in the labor market. Powell pointed out that, quote, as inflation has come down and the upside risks to inflation have decreased as the labor market has softened, inflation is probably a little further away from its target than is the employment, but I think the downside risks to the employment mandate are real now. Essentially, he explained that current conditions in the labor market are unlikely to drive a spike

in inflation. Regarding the risk of rapidly increasing unemployment, Powell positioned the Fed is vigilant, but not overly concerned at this point. He said, are we worried about a sharper downturn in the labor market? The answer is we're watching very carefully for that. The recent uptick in unemployment is historically correlated with a recession, leading to a rapid deterioration in the labor market as described by the SOM rule. Powell, though, was a little dismissive of that analysis, stating, I would call it a statistical regularity. It's not like an economic rule where it's telling you that something must happen. I think history doesn't repeat itself, it rhymes. That statement is very true about the economy. You never assume it's going to just be the same. The FOMC seems

to be viewing recent developments then in labor market as normalization rather than deterioration. Powell described it as, quote, a move from overheated conditions to more normal conditions. This probably explains why some of the Fed's rules have gone out the window and modeling is a little uncertain. There isn't really a historic example that compares to the post-pandemic era. Overall, Powell tried to paint the labor market is still quite strong, stating, I think you're back to conditions that are similar to 2019 conditions and that was not an inflationary economy. I don't think of the labor market in its current state as a likely source of significant inflationary pressures, so I would not like to see a material further cooling

in the labor market. Powell was clearly not. not concerned about waiting another six weeks to cut rates. The same could not be said for the press, with one journalist suggesting that the Fed is now risking unnecessary job loss for no real benefit. Powell didn't buy into the premise, stating, we look at the two goals. If one is further away from its goal, then the other, you concentrate on that one that's further away. The recent op-ed from former New York President Bill Dudley was presented for comment, specifically the quote that by delaying rate cuts, quote, it might already be too late to fend off a recession by cutting rates, dawdling now unnecessarily increases the risk. Powell accepted the criticism, but seemed to imply

that monetary policy choices are easier to make in the op-ed pages than in the actual meeting, stating, this is the judgment that we have to make. We're well aware of the judgment. We have to weigh the risk of going too soon against the risk of going too late. There was also a discussion of policy lags associated with rate cuts, which could mean the Fed really should be acting preemptively to get ahead of a recession. Powell accepted this as a real concern, but claimed that a major downturn isn't what he's seeing in the data. If a recession does rear its ugly head, Powell said, I feel good about where we are. We're certainly well positioned to respond to weakness with the policy rate at 5.3%. The implication here, of course, is that the Fed has plenty of room to cut aggressively if they need to.

When pressed about how he could be certain that waiting was the right decision, Powell responded, certainty is not a word we have in our business. Hello, friends, before we get back to the rest of the show, I want to implore you to join me at Permissionless. Permissionless is the conference for Cryptonatives by Cryptonatives, and the reason it's so important this year is that despite regulators' best attempts to push industry founders, devs, and executives out of the U.S., the United States remains the beating heart of crypto. Today, the tide is turning.

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and again, you can use code breakdown 10 to get 10% off. Now, a few other topics of interest were touched on. Powell did not take kindly to the idea that a September rate cut was a political action. Trump recently stated, that it would be, quote, something the central bank knows they shouldn't be doing. Powell responded that, quote, we never use our tools to support or oppose a political party, a politician, or any political outcome. The bottom line is, if we do our very best to do our part and we stick to our part, that

will benefit all Americans, that's what we believe and that's how we will always act. A question was asked about the status of a U.S. CBDC and whether the work had been abandoned. Powell was pretty clear that there are no plans to launch or recommend a CBDC, and that, quote, there's nothing really new going on. There's not much going on at all. He explained that work on a CBDC at this stage is mostly limited to keeping tabs on progress in other jurisdictions. Domestically, there doesn't seem to be any momentum, with Powell adding,

No one here has decided that we think it's a good idea yet. Commentary after the meeting was focused on what to make of the guidance. Many outlets fluent in Fed speak had heard enough to be convinced that September cuts were a lock. The Wall Street Journal editorial board wrote that Powell's message was that he, quote, is on the way to deliver an interest rate cut in September. KPMG chief economist Diane Swank said, it would take a major reversal in the inflation data to take September off the table. Former New York Fed President Bill Dudley commented,

the changes in the statement in the press conference today basically tell you that September is going to happen unless the economic outlook changes materially. Nick Timrose of the Wall Street Journal suggested, The bar to cut in September seems quite low based on everything Powell said at the presser. Neil Duda of Renaissance macro research said, it definitely sounds like they're just waiting for the sake of waiting. After all, by his own admission, all the data are already pointing in the direction he wants to see. Still, there were a few holdouts that weren't convinced, including many on crypto-Twitter

who seemed to want rock-solid guidance before they believe that rate cuts are here. And Barry of Threadneedle ventures said, What I heard was classic J. Powell, preserving optionality. We've got inflation coming down towards our target. At the same time, we're not heading for cliff levels in the labor market. I don't have the same conviction that the market has that there is going to be a rate cut in September. I did not hear that there's a catalyst that would make that a done deal.

Jeffrey Gunlock of double-line capital thinks the Fed should have cut today, but accepted that the risk of waiting is fairly small, stating, what difference does six weeks make? He picked up on the overly prepared nature of the press conference commenting, particularly in the answers to the questions he seemed to go into a script. But that's okay, he had to thread the needle. Powell did mention that there was serious back and forth about cutting rates at this meeting, so his comments might have actually been carefully brokered by different factions at the FOMC. Now, while there was a little confusion on the timeline, markets seemed to understand exactly what Powell was saying. Two-year bond yields continued

the decline that began last month, reaching a seven-month low of 4.25%. The two-year is generally seen is one of the best indicators of where Fed rates are going over the medium term, and this signal is screaming that cuts are on the way. If you'd stop here, that could be forecasting a stunted cutting cycle in a relatively high terminal rate. However, it would be unusual for the two-year to price all of the rate cuts before macro data has weakened much further than it already has. The CME's Fed-watch tool is now more than pricing in a rate cut in September. Traders currently see zero chance that the Fed doesn't follow through at the next meeting, and are pricing in an 11% chance that conditions deteriorate and a 50-bases point cut is necessary. The most audacious move was in the

stock market, which recorded its best day since February. The S&P 500 was up 1.6% while the NASDAQ jumped 2.6%. Magnificent 7 tech stocks led the way, up 3.5% in aggregate. Invigatea put in truly breathtaking numbers surging 13% and adding $329 billion to its market cap. That represents the largest single-day market cap gain in stock market history. Now importantly, and if you listen to the AI Daily Brief, you already know this, aside from the constructive Fed meeting, Nvidia also announced architecture improvements that should help with stimulating environments for robot applications, and Microsoft said that they were going to spend a crapload more money with Nvidia as well. Now, taken altogether, this certainly seems to be an indication that rate cuts are viewed as good

for stocks, at least in the short term. Some analysts still want to see more macro data before making a longer term call, with markets and mayhem tweeting, what happens after the first Fed cut? It all depends on the strength of the economy. If the economy does not enter a recession, the S&P 500 averages gains of about 12.5% over the year that follows. If the economy does enter a recession, the S&P 500 averages losses of about 13%. Quinn's Crosby of LPL Financial said, The market's positive reactions suggest traders and investors alike see the Fed easing at the September meeting

because inflation continues its path lower rather than an emergency rate cut because the labor market is deteriorating. Bitcoin was less enthusiastic about Powell's performance falling by 3% in the hours after he left the podium. Finance lawyer Scott Johnson, however, thinks this was less to do with the Fed meeting and more to do with a new correlation. He posted the polymarket chart for Trump's election odds,

which plunged to 54% yesterday and commented, The irony of the Trump speech is now the entire crypto industry is completely correlated to this one crypto event contract. Crypto Calayo urged the newcomers to take a deep breath, tweeting, Bros are acting like a few red candles are popping up on the screen and the bull market is over. Bitcoin hasn't even made a clean break yet above last cycle's all-time high. The real bull market hasn't even started yet. Chill. Now, with rate cuts on everyone's mind, some are questioning whether the Fed might be impotent given its massive debt load. In the morning prior to the FOMC meeting, the Treasury met to

finalize their debt issuance schedule for the next quarter. Throughout this year, been growing rumblings that this quarterly refunding announcement has become the most important event for financial conditions. The basic thesis is that by relying more on T-bills rather than longer-term bonds, the Treasury is able to increase liquidity in goose financial markets, undermining any tightness in Fed policy. The whispers began on FinTwit earlier this year and were taken mainstream by Noriel Rubini in a paper published last week. He claimed that Janet Yellen was manipulating treasury issuance in a way that would lower real borrowing costs across the economy. Yellen hit back, stating that Rubini's paper, quote, suggests a strategy that is intended to ease

financial conditions, and I can assure you 100% that there is no such strategy. Yesterday's announcement held bond issuance steady for the second quarter in a row, alongside a 14 billion increase in bill issuance. The larger change was an increase in treasury buybacks from 15 billion to 30 billion per month. This program commenced in June and was designed to retire old bonds that might struggle to find liquidity in the open market. Some are extremely sure this program is having a major impact, with Travis Kling of Ikegaid tweeting, tweeting, reminder, this is stealth QE or yield curve control with a different title slapped on it, and Yellen just doubled it.

Others have been a little more skeptical. Economist Alex Kruger walked through the mechanism when it was first announced. His conclusion was that, quote, contrary to popular belief, this is not quantitative easing. The central bank is not monetizing any debt. There is no money printing. These buybacks do inject liquidity in the short term only. Such liquidity would be withdrawn later on.

The impact on risk assets should be minor. In fact, the program seems to be fairly ineffective at doing anything at all at the moment. The last round of buying conducted last week saw zero bonds purchased. There was $3.7 billion in liquidity on offer, but no taste. So that is the macro story from here. I think that on the one hand, the market is right that this was basically as much as likely Powell was going to be to committing to a September rate cut. But at the same time, I also agree wholeheartedly with a person who said that this is classic Powell, still leaving himself room to wiggle out if necessary. For now, things remain data dependent, but we are

clearly headed to a new phase where rates will be coming down. However, that is going to do it for today's breakdown. Appreciate you listening or watching as always. And until next time, be safe and take care of each other. Peace.