The Breakdown - The 3 Blockers to Powell's Soft Landing

Episode Date: May 10, 2023

We got our report card today! Inflation surprised to the downside, coming in at 4.9%. NLW explores the reaction and why Powell still has three big barriers to getting his soft landing, including, notably, the debt ceiling negotiations.  Enjoying this content? SUBSCRIBE to the Podcast: https://pod.link/1438693620 Watch on YouTube: https://www.youtube.com/nathanielwhittemorecrypto Subscribeto 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 Wednesday, May 10th, and today we are talking about the inflation print and what it means for the tightening cycle, how it relates to the debt ceiling negotiations, and all that juicy macro stuff. Before we get into that, a quick note. If you were 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 conversations, come join us on the Breakers Discord. You can find a link of the show notes or go to bit. ly slash breakdown pod. Also, go check out Bitcoin Builders. We did a show on BRC 20 over the

weekend, and we have a new interview with Jason Meyer that just dropped this morning. But back to today's show, this week has seen a lot of interesting fallouts and consequences of last year's crypto chaos. For example, SBF resurfaced with the request to the judge in his case to throw out seven of the charges he's accused of. I'm reminded of the line from Dodgeball. It's a bold move, cotton. Let's see how it works out for him. On top of that, one of 2022's last institutional hanging chads in DCG is in a murky situation as it goes into mediation around Genesis debt payments that come do this month. Then there are the reports that big market makers like Jane Street and Jump are pulling away from the crypto markets

after finding themselves facing intense above the surface and likely behind-the-scenes political pressure. We will be discussing all of this this week, but today is inflation day, and so we're going to take a quick detour into the macro. Now, to give a sense of where we are, last week at the FOMC meeting, we got what some folks described as a hawkish pause. Obviously, the headliner was that the Fed raised rates, it raised them another 25 basis points, and this happened even in the face of the collapse, of First Republic Bank, which was seized on the Monday of FOMC Week. Now, for those who had been paying attention, it wasn't all that surprising, given what Powell and the Fed's posture has been. They have said since the beginning of this tightening cycle that they had the tools to deal

with problems that arise from tightening quickly. They basically said that they could handle financial stability and the fight against inflation at the same time, and that the interest rate wasn't really their tool when it came to financial stability. Indeed, what we saw around the time of Silicon Valley Bank is that the Fed, in addition to using its existing tools, created a new tool in the bank term funding program. The idea of the BTFP, remember, was to give banks whose loans were underwater the chance to borrow against the full value of those loans if they were held to maturity, rather than having to sell them at a loss to provide for liquidity when customers tried to withdraw. Billions and billions of dollars have been availed through that bank

term funding program, and by all accounts, the Fed seems to think that it's working. So, TLDR, the Fed continues to think that inflation is a big problem, and that it can handle financial stability issues without compromising on their fight against inflation. Now, the 25 basis point hike got the federal funds rate above 5% for the first time since 2009. And as Powell noted in the press conference, this rate had been what many at the Fed expected to roughly be the terminal rate. However, he would not commit to a pause or any sort of pivot. And this is why people called it a hawkish pause. While Powell did note that this was what many at the Fed thought would be the terminal rate, he made sure to project a clear message that the committee was biased towards more,

not less action. Basically, he was saying that the Fed was not guaranteeing a pause in any sort of way, and that, to put it over simply, they could take it back. Now, on top of that, he repeated the same thing that he said over and over, which is that when push comes to shove, everything is going to be based on the data. Now, the biggest piece of that data was what the actual inflation numbers show. This morning we got our report card. And heading into it, consensus estimates were calling for a 5% headline inflation rate in the April data with core inflation that strips out food and energy coming in at 5.5%. That would be a pretty flat reading because March's inflation data showed 5% headline

inflation with a 5.6% increase for core. Now, the question was, if the CPI did in fact stall out at 5%, would the Fed be satisfied to wait and see how it all played out, or would the lack of progress be enough to spur further rate hikes? Remember that at this time last year, CPI inflation printed above 8% and will continue to do so for the following five months. Since then, inflation has moderated significantly, but the Fed needs to see a viable path to 2% inflation with current policy settings to be confident enough to enter a rate pause at the next FOMC meeting. Now, that meeting will be held in the second week of June, beginning the day that the May CPI is released. That means in some ways this data will

be the last that they really have a chance to grok and comprehend, even if they will have early May CPI data as well. Adam Phillips of EP Wealth Advisors said, I think what it's going to tell us is that the path towards normalization is not linear. It won't change our thinking for the Fed. The market could respond since they respond to anything that's inflation related these days. But when you get down to it, I don't think it's necessarily going to change the Fed's calculus either. Now, in terms of markets, stocks traded down slightly into the end of yesterday's session, with overnight markets subdued in anticipation of today's print. Tom Asseye, founder of the Seven's report newsletter, said that equities could break higher if, quote, data points more convincingly towards a soft landing.

There are no more regional bank failures, core inflation drops faster than expected, the Fed confirms the pause, and a debt ceiling deal is reached, which is, you will notice quite a list of prerequisites to see a positive uptick in risk markets. Brent Donnelly, the president at Spectra market said, CPI tomorrow. Most of the people I talk to are leaning towards modest strength and core as services remain sticky. I think goods prices are falling back to Earth, but services will lag, and market knows this deep down, so we'll shrug off modest strength and go with any weakness. So what actually happened? Well, in point of fact, we got a slight surprise to the downside. Bloomberg's headline this morning declared, U.S. inflation shows signs of moderating,

giving Fed room to pause. Year over year, consumer prices rose 4.9%, which again was below the 5% expected and down slightly from last month. This was the first time in two years that we've been under 5% inflation. Now, once you take out energy and housing, service prices were up 0.1% in April, and year over year, they were up 5.1%. That's the lease since last July, and that's one of the most important data points to policymakers.

Now, when it comes to some of the specifics, shelter costs, which are a lagging indicator, are finally showing signs of moderating, which is really the data catching up to where we are. They rose 0.4% last month, which is the smallest increase in over a year. Prices for airfares, hotel stays in, new cars declined, and in many ways, prices were dragged up by used cars, which were up 4.4% on the month. In fact, as Gregory Deco, the chief economist at EY News wrote, bumpy disinflation. He points out just how many categories were going in weird directions opposite from one another.

Food, many pointed out with much excitement was at 0% which is a two-year low. Energy rose month over month by 0.6%. Overall, core goods were 0.6% up, but a huge part of that was used cars, which were up 4.4%. As mentioned before, new cars were down 0.2%. Apparel was up slightly at 0.3%. Now, services excluding energy, like I said, were up 0.4%. with shelter clocking in right at that 0.4%, which is its lowest in over a year, and other areas like hotel and medicine going down 3.4% and 0.1%, respectively.

U.S. Economics Editor at the Financial Times, Colby Smith, writes, Core CPI Services, once rent and OER as stripped out, came in at 0.113%. That's down from 0.4% last month, excluding shelter, it was running at 0.266%, just shy of March's monthly gain. Joe Wisenthal retweeted that and said, probably the most encouraging takeaway from this report. Powell has been talking a lot about core services excluding shelter, and that number came in really cool. I Toro's Callie Cox wrote, yep, biggest slowdown in the year-over-year pace of services excluding rent since May 2009.

But of course, it can't all be good news, right? There are too many people invested in doom for it to be so. And indeed, there is not only counterpoint data, there are also counterpoint narratives. For example, Zero hedge writes, inflation slowing, but wages slowing more. Real earnings are down for a record 25th consecutive month. In the 27 months of Biden's presidency, real earnings have declined 93% of the time. Getting outside even of what we might call partisan Twitter, even less biased commenters point out just how hard Powell's job is. Bloomberg's big take writes, Powell's bet against recession looks good, minus the credit crunch at a DC standoff and don't forget

El Nino. They write, In Powell's view, the gravity-defying strength of American labor markets is smoothing the way for a soft landing, even after five percentage points of interest rate hikes in a little over a year. Powell told reporters last week after raising rates for a tenth straight time, it's possible that this time is really different. However, what Bloomberg points out is that Powell's quest for a soft landing has to overcome some pretty serious obstacles. The three that they identify are one, a looming credit crunch, driven by the combined impact of Fed tightening and bank failures they write,

it will likely hit small businesses and commercial real estate especially hard. Number two, they say, is a debt-sealing deadlock in Washington. Quote, coming to a head right now, the partisan standoff threatens a period of intense financial stress. If the U.S. government does default, the blow to the economy and markets could rival the 2008 crash. And three, Bloomberg goes on, a climate wildcard from El Nino. The weather system is gathering force threatening extreme conditions around the world that would disrupt commodity supplies, push prices higher, and keep the Fed focused on inflation. End quote. Now, there is definitely a lot of chatter around the debt ceiling.

President Biden met with congressional Republican leaders yesterday for negotiations on raising the ceiling, but left with few signs of progress being made. After the hour-long meeting, Biden said, quote, over these last few days and weeks, there's going to be a lot of posturing, politics, and gamesmanship, and it's going to continue for a while. Still, he said he viewed the talks as, quote-unquote, productive. Republican House Speaker Kevin McCarthy had a different outlook, saying, everybody in this meeting reiterated the positions they were at. I didn't see any new movement.

McCarthy accused the president of ducking substantive negotiations with the spending cuts being asked for by Republicans. And given that we saw him tweet about blaming crypto investors and their tax loopholes, I'm not entirely sure that that's wrong. Now, as he was speaking to reporters, President Biden also discussed publicly theorized workarounds to the debt ceiling. He said that his staff had not looked into minting a trillion dollar coin, although they had considered invoking the 14th Amendment, which guarantees the validity of public debt, but held concerns that the Supreme Court would overturn the maneuver. Other leading Democrats are hitting out at Republicans as well.

Chuck Schumer, for example, asserted that McCarthy was holding the U.S. economy hostage by demanding large cuts to domestic programs and refusing to take an outright default off the table. Now, specifically what they're negotiating, last month the Republican-led House passed a bill that would raise the debt ceiling by $1.5 trillion in exchange for $4.8 trillion in budget cuts over over 10 years. The problem for the Biden administration is that the cuts would kneecap prominent programs from their agenda, including green energy subsidies and a boost to tax enforcement budgets. Earlier this week, Treasury Secretary Janet Yellen warned that raising the debt ceiling really is

the only good solution that won't risk economic harm. She asked for Congress to make it clear that they stand behind, quote, the basic principle that America pays its bills were not a deadbeat country. The White House is reportedly still pushing for a quote-unquote clean debt ceiling increase with no attached spending cuts. The debt ceiling is currently anticipated to be reached to the beginning of next month, but it could be even sooner. Negotiations continue with an additional meeting scheduled for Friday and likely many more to follow before the issue is resolved. Sven Heinrich summed up how many feel when he tweeted, The Empire of Debt has no choice but extend the debt ceiling or everything collapses. The pretense of sound and responsible budgets is just that, a pretense. Reality is

none of it can be sustained with current rates as ever more debt is required. Jay knows it. Janet knows. The Kobayisi letter writes, The U.S. is three weeks from a possible default. The U.S. Treasury said default could come as soon as June 1st if the debt ceiling is not raised. Even if it is raised, waiting until the last minute would be costly. This happened in 2011, the, quote, most volatile weeks since 2008. In 2011, U.S. Congress saw an ongoing debate about the appropriate level of government spending. The Republican Party wanted President Obama to negotiate over-deficit reduction, and the debate went on.

As a result, the U.S. was expected to go bankrupt on August 2, 2011. On July 31st, 2011, which was two days prior to the expected default, a deal was made to raise the debt limit. However, the days leading into July 31st were the most volatile since 2008. The result? U.S. markets crashed with the S&P 500 falling 19% in just three weeks in July of that year. Borrowing costs were said to have gone up by $1.3 billion in 2011, and it was later determined that borrowing costs actually skyrocketed by over $20 billion. We must avoid this scenario now. Waiting until the last minute to raise the debt ceiling would have massive.

implications. If it is not raised, even a partial default would result in a loss of over 5 million jobs. Next three weeks will be intense. Now, big minds in the market are thinking about all of this. Famed investor Stanley Druckenmiller has been quoted extensively recently on his views. In a recent discussion, he said, I make my money in chaos. I've always made more money in equity bear markets than I have in bull markets because that's when macro goes crazy. If I wasn't so worried about the country, I'd be salivating over the opportunities this is going to set up. On inflation, Drucken Miller said, this is really complicated. I've never seen this movie. If you put a gun to my head and said I was going to die if I'm wrong, I would say it's going

to go down to 2.5% or 3% over the next year or year and a half. Paul is going to panic because it's coming down because of a hard landing. Then it's going to go back up to 5 or 6 because he won't have squashed it. He let the genie out of the bottle, but I literally don't know. I could literally see a crazy hard landing, deflation after an asset bubble, or I could see 8% inflation? Very useful answer. I'm sorry, but that's all I got. Druck and Miller also talked about the U.S. dollar's status as the world's reserve currency. He said the CBO estimate for 2050 with a 4% interest rate, it had an 11% deficit. I'll tell you right now, if we have an 11% deficit, we're not going to be the reserve currency. We're not. You can already see things chipping away.

Most of the people who own our assets abroad, they hate us. I don't see them storing their wealth in dollars. Finally, he had this choice statement around the debt ceiling. All of this focus on the debt ceiling of the future fiscal issues is like sitting on the beach at Santa Monica worrying about whether a 30-foot wave will damage the pier when you know there's a 200-foot tsunami 10 miles out. Choice words, Mr. Drucken-Miller, choice words. So that's the picture. Slight surprise to the downside on inflation, not necessarily enough for Powell to back off, lots of jockeying around what it means, and the debt ceiling emerging as the big question for the next few weeks. Hopefully this was a helpful primer for you guys. I will certainly keep you posted as we learn more.

Until tomorrow, be safe and take care of each other. Peace.