The Breakdown - Sneaky Significant Changes at the Fed

Episode Date: March 21, 2025

It was FOMC day, and while rates stayed the same, there was much more interest and intrigue than there's been in many, many meetings. How are Powell and the Fed handling Trump's "What Next" economy? Sponsored by: Ledger Ledger, the world leader in digital asset security, proudly sponsors The Breakdown podcast. Celebrating 10 years of protecting over 20% of the world’s crypto, Ledger ensures the security of your assets. For the best self-custody solution in the space, buy a LEDGER™ device and secure your crypto today. Buy now on Ledger.com. 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, March 20th, and today we are talking about Fed 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 at the show notes or go to bit.ly slash breakdown pod. All right, friends, well, for most of the past year, Fed meetings have been something of a non-event.

Rates have largely been on hold, and the three rate cuts that we did have were more about adjusting to cooling inflation than about any setting of new monetary policy. There is always something to talk about, of course, but the Fed has been in wait-and-see mode, while they hope that inflation comes down and nothing breaks in the labor market. Generally, the story has been a lack of response to fluctuations in the data, as Chair Powell sits comfortably in his steady-as-she-goes mode. And although rates were held steady at 4.5% yesterday, this was anything but a sleepy Fed meeting. Trump's ever-changing tariff policy, a growth scare, a huge drop in consumer sentiment, and a stock market drawdown are all calling for a monetary policy reaction.

The only problem is that these catalysts are all pointing in different directions. And this, friends, was the theme of the Fed meeting, uncertainty. It was clear even before Powell stepped up to the podium when the Fed issued their statement. They scratched out a sentence about risks to inflation and unemployment, being. being equally balanced. In its place, the committee simply said, uncertainty around the economic outlook has increased. Once Powell took the stage, he hammered this point home. He uttered the phrase, uncertainty is remarkably high numerous times throughout the press conference. The Fed seems to know they need to make a call at some point in the near future, but they don't seem to know what

the call should be. Powell said the administration is implementing changes across four policy areas, trade, immigration, fiscal policy, and regulation. He added, it's the net effect of these policy changes that will matter for the economy and for the path of monetary policy. Uncertainty around the changes and their effects is high. As we parse the incoming information, we're focused on separating the signal from the noise as the outlook evolves. Cue your confused cat meme here. The meeting featured a new statement of economic projections, which shows how committee members are forecasting macroeconomic data. The CEP revealed some big changes in how the FOMC view the risks to the economy. Inflation expectations are up, with the members expecting core PCE to be stuck at 2.8% by the end of the year.

18 or 19 members saw inflation risks to the upside. This is a larger consensus than in June of 2022, when the Fed hiked by 75 basis points for the first time. Unemployment was forecast to rise to 4.4% this year, up from a 4.2% forecast in December. Meanwhile, growth is expected to drop to 1.7%, down from a 2.1% forecast in December. Rate strategist Rishi Mishra wrote, Most interesting SEP from the FOMC in a while. Clearest communication of stagflationary risks from tariffs we've had from the Fed. It will hurt growth and they won't be able to help as much because of the rise in inflation. The median of the dot plot remains forecasting two rate cuts this year. However, looking at dots from individual members, there has been a large hawkish shift from the

committee. In December, five FOMC members expected more than two rate cuts. Now, only two members believe additional rate cuts will be appropriate. There are now four members who think they won't be able to cut at all, up from two in December. Eight members in total are now penciling in one or zero cuts for the year, which is 40% of the committee. TLDR, while there are still two rate cuts on the plan, it wouldn't take much for the FOMC to start removing them if inflation heats up. Powell tried to downplay the changes to the SEP, stating that reductions in growth projections kind of balance out a rise in inflation forecasts. He asserted that, quote, on balance, people wrote down similar numbers. The changes aren't that big. Leaning on the theme of the meeting,

he added, the other factor is really high uncertainty. What would you write down? It's hard to know how this is going to work out. Bloomberg economist Anna Wong suggested this might have been a diplomatic answer, commenting, there's a bit of a disconnect between Powell's representation of the FOMC stance versus what is indicated in the SEP. One thing about Powell is that he is politically savvy. It could well be that he's talking down the hawkishness of the SEC to avoid the ire of the White House. The key issue facing the Fed in the near term is uncertainty around the impact of tariffs. Inflation expectations have moved up, with Powell stating that survey respondents are mentioning tariffs as the driving factor. However, he noted that longer term, expectations remain well anchored.

Powell was asked whether increased inflation forecasts from the SEC were solely to do with tariffs. He responded that, while it's difficult to pick apart the data, he conceded that, quote, the answer is clearly some of it. A good part of it is coming from tariffs. Fed's staff are now working on models they hope will distinguish tariff inflation from non-tariff inflation. Another big part of the Fed's analysis of tariff policy is figuring out whether it will cause persistent inflation or just a one-time price shock. Powell dusted off a current. term, stating, it's too soon to say about that, it can be the case that it's appropriate to look through inflation if it's going to go away quickly without action by us. If it's, and here's that term,

transitory, and that can be the case with tariff inflation. When prompted to confirm the Fed believes tariff inflation will be transitory, Powell added, that's kind of the base case, but we really can't know that. We're going to have to see how things actually work out. You might recall that during the pandemic, Powell maintained that inflation was transitory all the way through 2021, as it steadily ticked up to 8%. One member of the press decided to push Powell on this fumble, suggesting the lesson from the last time was that inflation quickly spreads through the economy if the Fed doesn't get on top of it. Unpacking what the Fed is doing to track tariff inflation a little more, Powell recalled the policies of the first Trump administration. He mentioned that

washing machines had been tariffed, but the price shock hit dryers as well, which were not subject to tariffs, commenting, things happen very indirectly. There will be a lot of work done in the coming months to trace that all through. The problem for the Fed is that the hard data and the soft data are starting to diverge. In the hard data, growth is marginally slowing. The labor market looks solid and inflation is starting to tick up, but it isn't alarming at this stage. But survey data from both households and businesses show a significant rise in uncertainty and concerns about downside risks. Powell commented, the relationship between survey data and actual economic activity hasn't been very tight. There have been plenty of times when people are saying very downbeat things

about the economy and then going out and buying a new car. Powell suggested that you that policy is in a good place to respond to whatever comes next, and the right thing to do is to, quote, wait here for greater clarity about what the economy is doing. Hello, friends, I am thrilled to share that Ledger is once again partnering and sponsoring with the breakdown. Many of you know, but for those of you who don't, Ledger is the most secure hardware wallet for your crypto and logins. It's trusted by 7 million users and secures 20% of the world's digital assets. What's more, Ledger is a lot more than wallets. Over the recent years, they've built a comprehensive ecosystem of products and services, all of which are designed

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to Ledger for sponsoring the show. At one stage, Powell was asked directly about recession risk. He responded, there's always an unconditional possibility of a recession at roughly a one-and-four chance at any time. The question is whether those possibilities are elevated at the moment. Powell noted that many outside forecasters are increasing their odds of a recession, but added that recession risk has moved up, but it's not high. One big action from the meeting is that while rates were held steady, the Fed is dramatically reducing their quantitative tightening program or their balance sheet runoff, as Powell calls it. Since June of 2022, the Fed has been allowing their portfolio of treasuries and mortgage-backed securities to mature without reinvesting the proceeds,

shrinking the balance sheet. This process has been running in the background ever since and reduced the balance sheet by over $2 trillion from its peak, around 23%. The rate of balance sheet runoff had already been reduced from $60 billion per month to $25 billion last June, and the Fed is now slashing the pace to just $5 billion per month. Minutes from the January meeting revealed this move was being considered to avoid Treasury market dysfunction during the looming fight over the debt ceiling. This implies that QT will be ramped back up once the ceiling is raised, which could take until August.

Powell insisted that the move had, quote, nothing to do with monetary policy. The effects of QT are far from certain, but the general consensus is that balance sheet reductions are tight policy and reduce liquidity in the market. For that reason, it was always a little strange that the Fed was cutting rates while keeping QT running in the background. And while this might not be a monetary policy decision, ramping QT back up could be a struggle. Former Fed trader Choseph Wang believes it's over, stating, you might as well say QT has ended. Now, throughout the current downturn, traders have been pining for the return of QE, when the Fed actively buys bonds and

increases their balance sheet. That always seemed like a fantasy anchored in the 2019 era, where the Fed abruptly abandoned QT and started buying bonds to address a liquidity crisis. The current situation is very different, and the Fed has plenty of room to cut rates before they go back to the emergency policy of QE. That said, ramping down QT is still positive for liquidity and looks kind of similar if you squint. Trader Andy Constan commented, temporarily tapering QT is not QE and it's not not QE. Real Vision crypto analyst Jamie Coutts posted, After last night, QT is effectively dead for some time. Treasury volatility has backed right off and is now mirroring the decline in the dollar from earlier this month.

this is all extremely liquidity positive. While the pace of the runoff in the Treasury portfolio was cut dramatically, the Fed will continue to allow mortgage-backed securities to mature at a maximum pace of $35 billion per month. Fowell said, we want the MBS to roll off our balance sheet. We strongly want that, but we haven't made any decisions about that yet. Many people believe buying mortgage-back securities in 2020 was a mistake in the first place. The logic goes that during the COVID crisis, the Fed reflexively bought MBS because that market was the epicenter of the GFC. Those issues didn't repeat, and the Fed may have contributed to skyrocketing housing prices by intervening. Taking it all together, this means the pace of QT has been cut in half, but longer

maturity MBS are now the bulk balance sheet runoff. And while you might think that QT isn't all that important, certainly Powell has encouraged that view over the past two years by rarely mentioning it, and insisting that it's just running in the background, this decision to taper quantitative tightening was important enough to cause Governor Christopher Waller to dissent yesterday. Waller agreed to hold rates steady, but would have preferred to keep QT running at the same pace. Powell has gone to pains to get unanimous decisions during his tenure, so dissents are always noteworthy. That goes double for Waller, who is often viewed as Powell's closest ally on the committee. Waller's public comments are even sometimes taken as reflecting Powell's private

views on controversial issues. For example, Waller floated rate cuts last November well ahead of consensus, saying something that Powell could never have said as chairman. Overall, it seems the end goal is to reduce the balance sheet as much as possible over the longer term. Nick Timmeros of the Wall Street Journal commented, as with last year's decision to taper monthly redemptions, this is about trying to maintain QT for longer. And you don't do that if you crash into the inelastically scarce reserve ditch. So how did markets take it?

Well, they responded positively, with the S&P 500 up 1.4% on the day. Bitcoin broke out of a one-week range, heading above $85,000 with a 5% gain. Jimmy Cox of Harris Financial Group thinks the market is optimistic about more easing from the Fed. Commenting, The Fed indirectly cut rates today by taking action to reduce the pace of runoff of its treasury holdings. This paves the way for the Fed to eliminate runoff by summer,

and with any luck, inflation data will be in a place where reducing the federal funds rate will be the obvious choice. Amanda Lyon, the head of macro credit research at BlackRock, thinks that this was just a big exhale after a punishing month, stating, a lot of that was baked in. We've had such a bruising few weeks in the equity market. Most forecasters have reflected lower growth in higher inflation, and that's part of what's driving us here. Quinn Thompson of Lecker Capital had a contrarian view of the meeting, claiming it was hawkish. He cited higher inflation, expectations, worth growth forecasts, and a clearly hawkish shift in the dot plot. Former New York Fed President Bill Dudley thought Powell's major contribution was just giving the

impression that he has everything under control. He said, Powell came in and gave a pretty doveish performance in the sense of, we got this, we're in a good place, we can afford to wait, we'll see how it goes, we're going to get the job done. He was pretty reassuring to people that this was all quite manageable. Perhaps the loudest response, however, came from President Trump himself, who posted the Fed would be much better off cutting rates as U.S. tariffs start to transition, ease their way into the economy. Do the right thing. April 2nd is Liberation Day in America. Now, while this is a little bit back to the old Trump calling for rate cuts at every Fed meeting, it is true that the Fed won't get

to respond to the April 2nd tariffs until the first week in May. If growth falls off a cliff and the labor market suffers, the Fed could quickly find themselves behind the curve. What's more, markets are already disagreeing with the Fed's assessment of the situation. They're pricing in a 60% chance of a rate cut in June and between four and six cuts for the year. One of the more interesting takes on where the Fed finds itself came from the Wall Street Journal's Nick Timmeros, who has very good sourcing at the central bank. He commented that, the Fed can cut because of good news. Inflation has declined, as was the case last year. Officials can also cut because of bad news. The economy is sputtering. The case for the first type of cuts has dimmed because sweeping tariff increases appear much more likely than they did

just seven weeks ago, when Fed officials last met. Timrose called this a big strategy shift at the Fed. There's no longer the option to deliver slow and steady rate cuts to achieve a soft landing. Instead, the Fed finds itself in a reactive position, waiting to see how Trump's policies will impact the economy. Basically, although the rate pause continues, the Fed is no longer waiting passively for inflation to come down. Instead, they're on the lookout for economic disruptions that require a reaction. But the uncertainty of the moment makes it nearly impossible to figure out what the next move should be, let alone get ahead of the curve. Jay Brice and the chief economist at Wells Fargo commented, it puts the Fed between a rock and a hard place. If inflation goes up, you want to be

tightening. On the other hand, if the unemployment rate goes up, you want to be loosening. And that, of course, doesn't deal with the scenario where both happen at the same time. So that is the story of the Fed. They seem just as confused as the rest of us. For now that, that is going to do it for today's breakdown. Appreciate you listening, as always. And until next time, be safe and take care of each other. Peace.