The Breakdown - The Fed Crushes the Idea of a UK-Inspired Pivot

Episode Date: October 1, 2022

This episode is sponsored by Nexo.io, Circle and FTX US.   On this edition of the “Weekly Recap,” NLW summarizes the Bank of England’s intervention into U.K. bond markets and covers comments from various Federal Reserve officials that make clear the BOE’s actions aren’t affecting Fed thinking in any meaningful way.  - Nexo Pro allows you to trade on the spot and futures markets with a 50% discount on fees. You always get the best possible prices from all the available liquidity sources and can earn interest or borrow funds as you wait for your next trade. Get started today on pro.nexo.io. - FTX US is the safe, regulated way to buy Bitcoin, ETH, SOL and other digital assets. Trade crypto with up to 85% lower fees than top competitors and trade ETH and SOL NFTs with no gas fees and subsidized gas on withdrawals. Sign up at FTX.US today. - I.D.E.A.S. 2022 by CoinDesk facilitates capital flow and market growth by connecting the digital economy with traditional finance through the presenter’s mainstage, capital allocation meeting rooms and sponsor expo floor. Use code BREAKDOWN20 for 20% off the General Pass. Learn more and register at coindesk.com/ideas. - “The Breakdown” is written, produced by and features Nathaniel Whittemore aka NLW, with editing by Rob Mitchell and research by Scott Hill. Jared Schwartz is our executive producer and our theme music is “Countdown” by Neon Beach. Music behind our sponsors today is “The Now” by Aaron Sprinkle and “The Life We Had” by Moments. Image credit: jehsomwang/Getty Images, modified by CoinDesk. Join the discussion at discord.gg/VrKRrfKCz8.

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 nexo.io, Circle, and FtX, and produced and distributed by CoinDesk. What's going on, guys? It is Saturday, October 1st, and that means it's time for the weekly recap. One note before we dive in. There are two ways to listen to the breakdown. You can hear us on the CoinDesk podcast network feed, which comes out every day in the afternoon and also features a number of other great CoinDesk shows, or you can listen on the breakdown-only feed which comes out a few hours later in the evening.

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Use code breakdown 20 for 20% off a general pass and register today at coindesk.com slash ideas. All right, friends, well, welcome to October, a contender for best month of the year in the definitive NLW rankings, competing only with that wonderful early holiday pre-Christmas December. However, right now, given what we're going through, the good tidings of holidays seem pretty far away. The biggest event of this week will definitely go down as being the chaos in the currency markets focused around the British pound. If you were somehow on vacation for the last week and don't know what's going on, first of all, good for you and second of all, here's the super TLDR. On Friday, the new trust government announced their economic plan, their mini economic

and the British markets do not like it. Now, it's not exactly clear whether that's because they think the central feature of the plan, which is a big tax cut, in fact, lopping off the top tax bracket, will be inflationary, or just because they think it suggests incompetence in the new government. It also, of course, could be some combination thereof, but in either case, the British pound was down 3.5% the day the plan was announced, which is one of its five biggest daily dips in the last few decades. That continued over the weekend with the GPP coming shockingly close to parity with the USD,

And that continued on Monday when the British bond market fell into turmoil as well. By Wednesday, the situation had become even more dire, and in fact, the Bank of England stepped in. Sam Coates, the deputy political editor at Sky News, wrote, I'm told, pension funds being hammered and losing huge amounts of capital, banks forcing them to make margin calls and liquidate assets, so guilt, some pension funds losing large amounts of their fund, hence BEOE stepped in. Now, the interpretations of all of this was interesting. On the one hand, of course, where the money-printer-go-Burmeams returning. However, the intervention

has had the desired effect of calming the market for now, with bond yields receding and the price of the GDP increasing slightly. Nathan Tankus from the excellent substack notes on the crises wrote a piece called Everyone Relax. The Bank of England keeping bond markets orderly is normal. Basically, he argues that this is a natural part of the central bank process. He concludes his piece, while the past week has kicked up a lot of dust, not all that much has changed. Fiscal policymakers act and central banks react. Bond prices and thus the yield curve reflects the stance monetary policy. When it gets out of line with the Bank of England's monetary policy stance, sooner or later the Bank of England will intervene to bring interest rates back into line.

Plumbing-focused bond purchases will become more frequent as interest rates continue to rise and, quote-unquote, things break. But this is not particularly concerning or abnormal. It's only unfamiliar to those who haven't read a lot of monetary policy history between the 50s and 80s. and if you haven't, that's what I'm here for. Monetary policy of the mid-20th century still contains a lot of lessons, which are all the more urgent now they have been forgotten. Now, as a quick aside, even if you don't agree with Tancas, in terms of his economic philosophies, and as Bitcoiners, many of you will not, I will just tell you that now. He still gives a ton of history and context for whatever he's writing about, and I think that means you learn, even if you don't agree with the conclusions he comes to. In any case, in this bad news is good news environment, which is so starved for morsels of hope, markets seem to treat the Bank of England intervention as a signal that the U.S. Federal Reserve would be forced

to do something similar, aka, the Fed would be forced to back off monetary tightening because of problems arising in the plumbing of the system. Markets had a slight rally on Wednesday, but by the end of the week, that hope had faded. In part, that was based on returning to more rational judgment outside the excitement of a crazy move. In part, it was because the Fed had a litany of representatives hammering the point that this would not make them back off. On Thursday, the S&P 500 fell as much as 2.7% after comments from St. Louis Fed President James Bullard. First, he affirmed that the market was correct that the Fed's dot plots mean more hikes. If you look at the dots, he said, it does look like the committee is expecting a fair

amount of additional moves this year. I think that was digested by markets and does seem to be the right interpretation. Second, he spoke explicitly about the UK, saying that the UK's problems would not cause the Fed to stop. Quote, we're determined to get to the right level of the policy rate in order to put meaningful downward pressure on inflation here. This is mostly about financial markets needing to price in the volatility that you're seeing in the U.K. So we have some movements in the U.S. because of that. I don't see this really impinging on the U.S. inflation or real growth developments. Cleveland Fed chief Loretta Mester also spoke and reinforced that there is just a lot more work to be done.

Real interest rates, she said, judged by the expectations over the next year of inflation, have to be in positive territory and held there for a time. We're still not even in restrictive territory on the funds rate. She also drew a difference with the U.K. It's a challenging situation for them, she said. For financial stability reasons and for market functioning reasons, they had to go in and buy bonds. Market functioning is incredibly important because you won't be able to hit any monetary policy goals if the markets aren't functioning. That's different than worrying about volatility in markets.

She went on and said that so far, there had been no sign of dysfunction in U.S. financial markets. Now, what's more? All of this echoed comments from Fed officials earlier in the week as well. St. Louis Fed Chief James Bullard, a longtime hawk, said that the Fed needed to keep raising interest rates to combat inflation, warning that the Fed's credibility was on the line. quote, this is a serious problem and we need to be sure we respond to it appropriately. We have increased the policy rate substantially this year and more increases are indicated in the Fed's latest forecast. He went on. We've just now gotten to the point where we can argue we are in restrictive territory. I think we need to stay at that higher rate for some time to make

sure we've got the inflation problem under control. Bullard also discussed the connection between rising unemployment and falling inflation, recognizing that the relationship has not worked in recent years. He instead suggested that inflation might be reduced through inflation expectations rather than causing mass unemployment. We've got a better chance of success with less disruption to the economy than Volker would have had. He instead referred to the 1990s Greenspan Fed, which successfully raised rates by three percentage points without a recession, setting the stage for the most successful economy in U.S. history during the second half of the 90s. For what it's worth, I don't think a lot of people agree with those particular comparisons. Minneapolis, Fed Chief Neil Keshgari, speaking at a different

event, said that the Fed should keep tightening until there was compelling evidence that core inflation and then be patient to confirm the end of this inflationary period. The one mistake that I'm acutely aware of, he said, that I want to avoid repeating from the 1970s, is when policymakers saw the economy weakening, saw inflation start to tick down, and then they cut rates, thinking they had done the job, and then inflation flared back up again. That, I believe, is a mistake we cannot make and will not make. At the same time, Kashkari recognized the danger of going too far with rate hikes. There's a lot of tightening in the pipeline. We are committed to restoring price stability,

but we also recognize, given these lags, there is a risk of overdoing it. When asked if he saw cause to hike by 100 basis points, he said, the pace that we're undertaking right now is appropriate. The message from the Fed couldn't be clear right now, and no amount of the UK looking wonky is going to change that. Want to keep more profits when trading? Get the best possible prices and trade with 50% lower fees on NXO Pro. The new Spot and Futures trading platform uses aggregated liquidity

of over 3,000 order books collected from multiple sources. Utilizing the complete nexo suite allows you to earn interest and borrow funds as you wait for the next trade setup. Visit pro.nexo.io. That's p.r.0.nexo.i. and sign up today. The breakdown is sponsored by FTXUS. FtXU.S. is the safe, regulated way to buy and sell Bitcoin and other digital assets with up to 85% lower fees than competitors. There are no fixed minimum fees, no ACH transit. action fees and no withdrawal fees.

One of the largest exchanges in the U.S. FDXUS is also the only leading exchange that supports both Ethereum and Solana NFTs. When you trade NFTs on FTCS, you pay no gas fees. Download the FTCS app today and use Referral Code Breakdown to support the show. As we've discussed, if things aren't breaking, that leaves the only catalyst for a Fed shift outside a dramatic downshift in the rate of inflation as signs of softening in the labor market. So what about jobless claims this week?

Did we see an uptick or anything that would make us think there might be a change in the air? In short, the answer is nope. In fact, U.S. jobless claims fell to their lowest level since late April. There were 139,000 initial jobless claims versus an estimated 215. Continuing claims were at $1.347 million versus the expected $1.385 million. The four-week moving average has also declined for the fifth straight week. Interestingly, some are viewing this as a self-reinforcing cycle. Ian Shepardson, the chief economist at Pantheon macroeconomics said,

with labor still very hard to find, firms probably are holding on to people who under normal conditions would have been laid off. At this point then, the softening of the labor market, which the Fed wants, appears unlikely to come via rising layoffs. So if you are a Fed watcher hoping for something good there, he kind of out of luck. Now speaking of self-reinforcing cycles, let's catch up on housing. The average 30-year mortgage in the U.S. now sits at 6.7 percent, which is the highest average since 2007. That's up from 6.29% last week, and in many places, mortgage buyers are actually seeing rates above 7%. The last time the average rate crossed 7% was 2002. This has put a huge thaw on the markets. Contract signings for previously owned

homes plunged almost 23% last month from a year earlier. House prices, still far ahead of a year earlier, are turning south for the first time in a decade. According to the S&P K Schiller Index published on Tuesday, the national measure of house pricing across 20 major cities fell by 0.44% in July. This is the first drop on this metric since March 2012, representing a 10-year run of month-after-month price increases. The largest drawdowns in July were in San Francisco at 3.6%, Seattle at 2.5%, and San Diego at 2%. Now, prices remain elevated despite the change in direction for the market. The index still shows a 15.8% year-on-year increase. While this is still a historically large yearly increase, it's the smallest yearly metric since April of 2021. It also represented the largest single month of deceleration

in the history of the index from the 18.1% annualized increase reported in June. Scott Bukta, the head of fixed-income strategy at Breen Capital, said it's an affordability-led downturn. We've never really moved us far so fast. There are a lot of things going on here. The first is mortgages cost more, that's the obvious one, but it's having dramatic impacts on what houses people can afford. This has become the most popular new subgenre on Twitter, doing the math around what a mortgage will buy you this year versus last year. Joe Wisenthal tweeted this week last year, if you could swing a $2,500 payment and 20% down payment, you could purchase a $750,000 house. Today, that $2,500 payment gets you a $476,000.

house. People are also less incentivized to put their house on the market. This is that golden handcuffs idea. If you locked in a mortgage in the twos, threes, or even four percent range, do you really want to leave that to get into a new mortgage where your money goes so much less far? For most people, the answer is no, and that's causing an additional constraint on supply. Another space that people are watching outside of housing is corporate earnings. One story on that front that made some buzz this week came from Apple. Apple is walking away from plans to increase production of its newest iPhone. after an anticipated surge in demand failed to materialize. Apple is now asking suppliers to reduce ramped-up production by as many as 6 million units

for the second half of this year. Instead, it aims to bring 90 million headsets to the market, about the same production as last year, and in line with its original forecasts. Demand for the Premium Pro model is stronger than entry-level units, leading some suppliers to switch production to the up-market model. Apple shares are down 18% this year, which is kind of robust compared to the 23% fall in the S&P 500 index. Bloomberg intelligence analysts of Nura Grana said he was not surprised by the collapse in demand,

saying that he continues to, quote, believe that weak demand from Europe and China could hurt overall iPhone sales in fiscal 2023. Overall, the smartphone market is expected to shrink by 6.5% this year to 1.27 billion units, according to data from market tracker IDC. The research director at IDC said, quote, the supply constraints pulling down the market since last year have eased and the industry has shifted to a demand-constrained model. High inventory and channels and low demand with no sites of immediate

recovery, has OEMs panicking and cutting their orders drastically for 2022. Fred Hickey, the editor at high-tech strategist, wrote, this is a shock, though not to me, as I've been making the argument in my monthly HTS letter all year long, that Apple's smartphone sales would not be immune from the global economic downturn. With stocks already on very shaky ground, this could have major market ramifications. Apple's 25 p-to-e ratio on inflated earnings and 2.44 trillion market cap weren't justified even on analysts' rosy iPhone 14 forecasts. But this will likely just be the first of multiple disappointments as the first few weeks always sees the early adopters buying. Once early adopter buying ebbs and those with iPhone buyers typically purchase the higher end,

newest models with all the bells and whistles, the true sustainable level of demand emerges. But this time, demand is fading extremely quickly, and that's a big problem for stock market bowls. We are heading into earnings seasons and a lot of people are looking for signs of forthcoming growth slowdowns in those earnings reports. For foreign-facing U.S. stocks, it's even worse. 22V research argues that S&P firms with high foreign sales exposure are underperforming by 17%. Their research argues that the dollar's rise threatens to wipe out $60 billion in sales from the biggest U.S. firms. Wrote the founder, The dollar is an increasing headwind to S&P topline growth at a time when earnings are coming under pressure

from slowing demand and a needed decline in profitability. Companies with high foreign sales exposure are most at risk. To try to sum up, Where we are is that a lot of the theories that people have had about the problems of a strong dollar, about weaker corporate earnings, about a housing market that finally turns, about bond markets in turmoil, about currencies even from major economies having big problems, all of these things are now becoming real. The question is just, how much turmoil can the markets really take?

It's not a question they've been forced to answer for some time, and now it seems the time has come. For now, I want to say thanks again to my sponsors, nexus.io, circle and FTX. And thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace.