The Breakdown - ‘Soft Landing’ Is Out. ‘Growth Recession’ Is In.

Starting point is 00:00:00 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 produced and distributed by CoinDex. What's going on, guys? It is Friday, September 2nd. And today we're talking about growth recessions. 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,

Starting point is 00:00:37 come join us on the Breakers Discord. You can find a link in the show notes or go to bit.ly slash breakdown pod. Also, a disclosure as always. In addition to them being a sponsor of the show, I also work with FTX. All right, folks, well, this morning we got the new jobs numbers. And as we've discussed before, jobs data represents one of the key pieces of information for the Fed as they determine how aggressive they're going to be about their plan to raise rates and tighten monetary policy. If jobs numbers came in soft, that might make them think that the impact of tighter monetary policy is finally working its way through the economy and having the cooling effect that they're looking for. If, on the other hand, data shows that the labor market remains tight, with employment levels really high,

Starting point is 00:01:21 this could be a signal that the Fed could tighten even further. Now, for some context, in July, we had a surprise to the upside, when over 500, thousand jobs were added. The Biden administration immediately used this as evidence that all this recession talk was just a bunch of hooey. However, as I discussed in a show around that time, the top line numbers hit a lot more questionable data underneath. It turns out that we added lots and lots of part-time jobs and lots and lots of people taking on second jobs. When it came to full-time jobs, we actually saw a reduction by about 70,000. This to me reads like a situation where some people were having to move from full-time to part-time, and others were having to take on

Starting point is 00:02:01 additional jobs to keep up with the cost of living. Now, ultimately, I argued that I didn't think that the Fed was going to be making any decisions just based on those top-line numbers, even if that's what politicians used to advance their narratives. But in any case, subsequent to that event, we've seen a Fed that has used every media chance it's had to reinforce that they are not going to back off inflation till it's dead. Potential for recession be damned. In fact, U.S. stocks have fallen, every day since Fed Chair Jerome Powell's speech at Jackson Hole. The price action represented a marked shift from sentiment earlier in the summer, where the prevailing narrative, coming off of the July FOMC meeting, was that inflation had peaked and that the Fed would be able to pull off a soft

Starting point is 00:02:40 landing. Now, I think that the argument is compelling that people who were overly bullish after that July FMC meeting were the same people who are now rightly correcting but seem overly bearish post Jackson Hole. In any case, it's pretty clear that the Fed is planning on a recession. Von Lipsy, a managing director at UBS Private Wealth Management said, with each interest rate hike, the ability to stick that landing and make everyone happy that's getting more and more difficult to do. UBS is now forecasting a 60% chance of a U.S. recession, which is up from 40% in June. With the S&P currently down 17% on the year, the equity market appears to have already

Starting point is 00:03:15 priced in a mild recession, but not necessarily a deep one. According to Brent Schutt, the chief investment officer of Northwestern Mutual Wealth Management, analysts are noting that no real contraction in corporate earnings has shown up in financial statements so far and therefore hasn't been priced in. A recession without a corresponding reduction in earnings would be extremely unusual. Keith Lerner, the chief investment officer at Truest Advisory Services, said, the challenge for the markets is even if the Fed thinks that inflation is slowing, they're not going to talk differently until they're thoroughly convinced that inflation is tamed. Indeed, there is an entirely new language around this. Soft landing is out. Growth recession is in.

Starting point is 00:03:52 Diane Swank, the chief economist at KPMG, told Bloomberg that the Fed has given up its hopes for a, quote, soft landing and now recognizes a, quote, growth recession is necessary to reduce inflation. In other words, that the Fed will need to slow economic growth to well below its potential. She went on to colorfully describe it as, it's a bit like dripping water torture. It is a torturous process, but less torturous and less painful than an abrupt recession. Loretta Maister, the president of the Federal Reserve Bank of Cleveland, said on Wednesday, quote, I believe that the Fed has more work to do in order to get inflation under control. This will entail further rate increases to tighten financial conditions, resulting in an economic transition to below-trend growth in nominal output, slower employment growth, and a higher unemployment rate.

Starting point is 00:04:34 Bill Adams, Comerker's Bank chief economist, said, my interpretation of Chair Powell's Jackson Hulls speech, and in particular, his statements that he expects some pain for households and businesses, is that it sounds a bit worse than just a period of growth that's below the U.S. economy's trend. So I think the Fed would like to see a growth recession, but it's also prepared for the possibility that an outright recession is necessary to bring inflation durably back to their target. Now, this is kind of a fascinating moment. Growth recession is just about one of the most Fed-speak things you've ever heard, but it's being pushed not exactly by the Fed, but by media

Starting point is 00:05:05 channels. I don't think it's coordinated, but it is notable that this language sort of appeared out of nowhere and is now showing up in lots of places. The term itself was actually coined by Solomon Fabricant in 1972. Fabricant was a New York University professor and President Dwight Eisenhower's chief economic advisor. The idea of a, quote, growth recession came from an analysis of the economic slowdown in 1969 and 1970. Fabricant argued that we needed effectively more gradation in our recession language. However, wherever the original term came from, Twitter was all over its use right now. Rudy Havenstein tweeted growth recession? Isn't that an oxymoron? Like jumbo shrimp or Fed credibility? Jeff Snyder said,

Starting point is 00:05:46 now they're trying to call it a growth recession. What the hell is that supposed to mean? People who won't be able to afford gasoline are having a driving recession. The millions being forced to food banks are experiencing an eating recession. When's the Fed recession? Markets and Mayhem said first inflation was transitory, then the landing was to be soft. Now we're starting to hear some harder truths. The Fed favors a growth recession. This idea of the evolving narrative is everywhere. Sven Heinrich writes, keeping tabs on the evolving Fed narratives. Soft landing, softish landing, growth recession. All of that said, there are some who think, whatever the narrative might be, that the Fed is not

Starting point is 00:06:22 going to be able to get away with just a growth recession, but is going to need a, you know, good old-fashioned recession recession. Bill Adams again from Comaker said, I'm looking at the inverted yield curve, the declines in business and consumer sentiment surveys, the decline in the conference board leading economic index for the United States, the downturn of housing indicators, and all of these indicators collectively now look like they typically have prior to previous recessions in the United States. Nexo is a security first platform built for the long run with everything you need for your crypto. Five key fundamentals, including real-time auditing and insurance on custodial assets,

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Starting point is 00:08:45 that prices and the cost of living are just a huge problem. A new report from the Department of Agriculture dramatizes this problem in the context of food. According to the report, the cost of growing food is set to increase in 2022 by the largest amount ever. The report forecasts a cost increase of $66.2 billion in aggregate across the agricultural industry, an 18% year-over-year growth. The largest increases were in fertilizer and feed as the loss of products from Ukraine and Russia impacts markets throughout the world. To put some numbers around Ukraine in terms of wheat, Karen Braun, the global agricultural colonist at Reuters, tweets, Ukraine's Agrarian Council says wheat plantings for the 2023 harvest could fall 30 to 40% due to lack of funding.

Starting point is 00:09:28 And crop won't exceed 15 million metric tons. That compares with 19 million metric tons in 2022 and 32.2 million in 2021. Ukraine's agricultural ministry had said plantings at least 20% down year over year. Sewing starts soon. Ukraine's farmers planted the 22 wheat crop last fall, before the full-scale invasion started. So this is the first wheat crop they will try to plant in the invasion era. Ukraine's grain exports in August were 60% lower than last August. Now, bringing it back to the U.S., the U.S. Department of Agriculture also updated harvest

Starting point is 00:09:59 forecasts this week, and alarmingly, they're forecasting 13.759 billion bushels of corn to be produced. That's down 4.2% from estimates made just two weeks ago, and represents the lowest corn harvest since 2019. Pro Farmer, which is a farming newsletter that conducts an on-the-ground data collection campaign each year, had an even more pessimistic view, estimating corn yield per acre. at 4% lower even than the agricultural department's estimates. Given that the U.S. is the world's largest corn producer, a shortfall in corn exports will impact both food inflation for human consumption as as well as livestock feed. So this is some of what's going on as we come into first these jobs numbers and more broadly what the Fed decides to do next. In terms of what people anticipated,

Starting point is 00:10:41 overall, economists forecast that we would see 298,000 jobs added last month and predicted that unemployment would stay at 3.5%, which is a five-decade low. In terms of performance, professional investors, the big theme is good news is bad news. Adam Phillips, the managing director of portfolio strategy at EP Wealth Advisers, says, we're in an environment where strong economic data will be perceived as negative by investors because it strengthens the Fed argument for more aggressive policy tightening. If Friday's numbers come in weaker than expected, you could see a positive market response, since that might signal that the Fed can get away with taking some pressure off the economic breaks for now. If, however, the number comes in sharply lower than expected,

Starting point is 00:11:17 markets could sell off if investors see that as a sign that economic slowing is already well underway. So what actually happened? Well, the numbers came in slightly above estimates, but no big shock like last month. Employers added 315,000 jobs. Notably, however, the unemployment rate was also up slightly to 3.7%. That 3.7% is actually a six-month high in the first increase since January. How could employers add that many jobs, but see the unemployment rate go up? The answer is that we saw an increased participation. rate. In other words, more people looking for jobs. Overall, this is a pretty middle-of-the-road report. It certainly doesn't suggest for some big shift where Fed tightening is finally hitting the labor markets. At the same time, it does give some early indicators that monetary policy is having an

Starting point is 00:12:02 effect. Joe Wisenthal said, this report seems soft landing-ish, pace of job creation still robust, wage growth cooler than expected, and unemployment rate jumped due to more people entering the workforce as opposed to layoffs. And indeed, the part that I think the Fed will be most focused on is this increase in participation. A larger supply of workers could lead to a cooling of wage pressure. And for the Fed, that eases their chief concern of entrenched inflation expectations setting off a wage price spiral. However, it seems unlikely that anything in this report is so dramatic that it's realistically going to change the way the Fed thinks about what they're doing in September. A group of economists for Bloomberg agree, saying the August report contains some good

Starting point is 00:12:40 news for the Fed's chances of engineering a soft landing with more people joining the workforce. As long as that trend is sustained, wage growth could moderate, even as strong hiring continues. But we are pessimistic. Both the aging of the population and the impact of long COVID imply that the participation rate will be slow to return to its pre-pandemic level. Now, netted out, all of this puts a lot more onus on the inflation numbers as the factor that will have the biggest decision on the next rate hike at September's FOMC meeting. Those inflation numbers will be released on Tuesday, September 13th. The one other thing, however, to watch for during September is that we're not just experiencing rate hikes right now,

Starting point is 00:13:16 but actual quantitative tightening. The process of quantitative tightening that the Fed is going through, or balance sheet reduction, means that the Fed is shrinking the size of its balance sheet by allowing bonds that mature to fall off without replacing them. The cap on the volume of bonds that the Fed will allow to roll off its balance sheet without replacing will double to $60 billion per month for government bonds and $35 billion per month for mortgage-backed securities. The QT program has been controversial among commentators. Some note that since the asset roll-off started in June, we've only seen a $63 billion reduction in the gargantuan $8.9 trillion Fed balance sheet. Mortgage-backed security holdings actually increased by $18 billion during this period. However, former senior Fed trader

Starting point is 00:13:56 Joseph Wang has repeatedly explained that various quirks related to the lag in settling trades meant that the reduction in the balance sheet can take months to be properly reflected in the data. Wang said that these effects should begin to catch up and be properly reflected in the data soon. Quote, just wait for September. QT is taking place exactly as the Fed is telegraphed and the balance sheet declines will become more apparent in the coming months. Soon the QT pace will quicken, and all past-purchased mortgage-backed securities will have settled. From that time, the Fed's balance sheet will clearly and steadily decline each month. Also expected in September is that for the first time during this QT program, the Fed will be reducing its holdings

Starting point is 00:14:31 of short-term Treasury bills. The currently forecast reductions of Treasury bill holdings are $16.4 billion in September and $13.6 billion in October. It's noteworthy that we just are kind of in uncharted territories here. A TD security strategist said, quote, this is the first time the Fed is allowing bills to run off their balance sheet, three years after they started buying them quickly due to a reserve shortfall. QT is hitting its full stride. So the overall point here is that September should mark the start of a much more obvious and severe reduction in the Fed's balance sheet than during the first three months of the QT program. analysts at Axios anticipate liquidity being removed from the market at an annualized rate of around $1 trillion per year during this phase of QT. It's

Starting point is 00:15:12 what the effects of this will be. This size of balance sheet reduction has never been performed, and academics are unsure of the impact on markets. Bill English, a professor at Yale School of Management, who previously served as the head of the Fed's Monetary Affairs Division, said, I don't think they know as well what the macroeconomic effects are of adjusting the balance sheet. On yesterday's show, I predicted an autumn of action as related to crypto regulatory affairs, but it certainly seems that the setup is also true for traditional markets as well. You can bet that the markets will be closely watching first what happens in terms of the inflation numbers in a couple weeks, and then second, what happens at the FOMC meeting after that. I will, of course, be here to break it down for you guys when that happens.

Starting point is 00:15:54 For now, I want to say thanks again to my sponsors, nexus.com.i.o, chain analysis and FtX. And thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace. I want to tell you about CoinDesk's new event, the investing in digital enterprises and asset summit, or ideas. The event facilitates capital flow and market growth by connecting the digital economy with traditional finance. Join CoinDesk October 18th and 19th in New York City for a 360-degree investment experience, where you can source, invest, and secure the next big deal in digital assets. Use code Breakdown 20 for 20% off a general pass. You can register today at coindesk.com slash ideas.

The Breakdown - ‘Soft Landing’ Is Out. ‘Growth Recession’ Is In.

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