The Breakdown - The Fed’s Hawkish Walk Back

Episode Date: February 8, 2023

At last week’s FOMC meeting, Federal Reserve Chair Jerome Powell surprised many market watchers with a more doveish than expected FOMC speech and Q&A. On Friday, however, the January non-farm payrolls report came in with 517,000 new jobs added – far more than the 185,000 economists expected. Early this week, the Fed responded by deploying a number of officials to suggest that the continued tightness of the labor market was justification for more rate hikes this year. Enjoying this content?   SUBSCRIBE to the Podcast Apple:  https://podcasts.apple.com/podcast/id1438693620?at=1000lSDb Spotify: https://open.spotify.com/show/538vuul1PuorUDwgkC8JWF?si=ddSvD-HST2e_E7wgxcjtfQ Google: https://podcasts.google.com/feed/aHR0cHM6Ly9ubHdjcnlwdG8ubGlic3luLmNvbS9yc3M=   Join the discussion: https://discord.gg/VrKRrfKCz8   Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW   - Join the most important conversation in crypto and Web3 at Consensus 2023, happening April 26-28 in Austin, Texas. Come and immerse yourself in all that Web3, crypto, blockchain and the metaverse have to offer. Use code BREAKDOWN to get 15% off your pass. Visit consensus.coindesk.com. - “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 sponsor today is “Foothill Blvd” by Sam Barsh. Image credit: Kevin Dietsch/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 produced and distributed by CoinDesk. What's going on, guys? It is Tuesday, February 7th, and today we are talking about the Fed's hawkish walkback. Before we get to 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 Breaker's Discord. You can find a link in the show notes or go to bit.ly slash breakdown pod.

All right, guys, well, this show felt pretty inevitable after last week's FOMC meeting. If you're a regular listener, you will have heard me talk about this pattern of interaction that the Fed has had with markets since at least a year ago when the tightening cycle began. Basically, the Fed says, hey, we've still got a ways to go in all sorts of various forms. After a while, the market either gets bored of markets being bad or susses out some data point that it's it uses to convince itself that the Fed's hand is going to be forced and that a pivot is inevitable. This has tended to be a bad news is good news thing where the market basically doesn't believe Powell and Co that they'll hike into a recession. Anyway, the rally goes on for a little while before finally the Fed starts deploying officials to try to tamp it down. They usually reserve

Powell for the harshest version of this. This happened what feels like a half dozen times last year, but the most notable was the Jackson Hole speech at the central banker's big event in August. Apparently, Powell's plan speech was scrapped at the last minute for the eight-minute speech we got, which really threw cold water on the late summer market rally. Anyway, this was the pattern that everyone had in mind heading into last week's FOMC meeting. It was sort of a foregone conclusion that the Fed was going to hike by 25 basis points. All the signaling had confirmed that that more or less was locked in, which left the big question being then what Powell's tone was going to be.

Remember, there are really three data points that markets digest from these meetings. The first is the interest rate change itself. The second is the forward guidance, which can be specific numbers in the form of their dot plot, or can just be tonal. In many ways, this sort of guidance matters more than the interest rate change by the time the meeting happens, unless the rate changes itself a huge shock. Markets are forward-looking, and so the guidance gives them an orientation for how the Fed is thinking about the future. The third data point is the meeting minutes which come out the following month

and are effectively another chance for the Fed to have one more whack at reorienting markets if they didn't get the memo. Now, coming into this FOMC, the market had had a great January. The Dow was up 3%, the S&P 500 was up 6%, and NASDAQ was up 11%.

Bitcoin obviously did even better. At the same time, the December FOMC meeting minutes released in January did suggest that the Fed was worried that markets would rally too hard while there was still more tightening to go. It would have seemed then a perfect time for Powell to come out hawkish last week, and he just sort of didn't do that. Many commentators argued that he rhetorically missed the mark. They assumed that it had been his

intention to come out harsh and he just screwed it up. I was somewhat less sure. My argument was that Powell knows how to speak to markets at this point, and if he didn't come out fully hawkish, he had a reason for doing so. My guess was that he actually thinks he might get his soft landing now, for the first time, even though he's been saying it for a year. And so because of of that is towing a more careful line. And yet, and yet, here we are a week later with the Fed trotting out speakers to amp the hawkishness back up. So what happened? The major data point, which has caused a rethink on the strength of the economy, was Friday's non-farm payroll report for January. The establishment survey showed a scorching hot 517,000 jobs added for the month,

which far exceeded the 185,000 forecast and almost doubled the 223,000. increase in December. The unemployment rate dropped to 3.4%, a 50-year low. Now, this matters extra, because Powell and the Fed have gone out of their way to say that employment and tightness in the labor market is their biggest concern at the moment. They see it as keeping the risk of wage price inflation high and basically don't see a way to stop tightening until the labor market eases. There had been some indicators that wage growth was cooling, but then all of a sudden they get this big, blaring statistics. More than twice the number of jobs added than expected very nearly 3x.

For the headlines alone, this was problematic. And indeed, to some, it was mostly a headline issue. Because while the non-farm payroll data told the story of runaway strength in the labor market, analysts were not always keen to take the report on face value. Now, to understand why, we need to do a little background on the structure of the data. The report consists of two parts, the household survey and the establishment survey. The establishment survey queries businesses and employers, but they, biggest difference is that it is smoothed in an attempt to model a continuous data series.

To this end, the data is massaged with seasonal adjustments. The household survey is more or less the direct reporting of survey results regarding employment status from a sample of households. Its underlying population estimate is updated annually, but it isn't seasonally adjusted. The establishment survey presented this eye-popping strength in the data, while the household survey came in much more soft, contradicting the rest of the report. What was going on? well, after almost three years of pandemic restrictions impacting economic data, the seasonal

adjustments are understandably a little warped. January's seasonal adjustment carries an assumption that additional workers hired for the Christmas season will be retrenched, but some analysts are suggesting more firms retain their additional workers this year. Wells Fargo economists said in a note, seasonal adjustment factors appear to have flattered the headline as smaller than usual post-holiday layoffs bolster the payroll numbers. We suspect members of the FOMC will take January's blowout employment report with somewhat of a grain of salt. In other words, the argument here is that people who normally would have been laid off after having been hired for the season might have had their contracts extended because employers are scared of having to go rehire that

talent later. Now, this isn't the only time we've seen a one-off outsized jobs number. In July of last year, the report showed 528,000 new payrolls, but quickly reverted to a much more reasonable number the following month. Bloomberg economist Anna Wong and Eliza Winger said, if it seems too good to be that's because it's too good to be true. The gain is mostly due to seasonal factors and revisions to pass data. Still, it can't be denied that the labor market remains tight. The Fed won't place too much weight on this headline jobs number one formulating policy. Jennifer Lee, senior economists at BMO Capital Markets, pushed back on the skepticism, stating, we can't completely dismiss all of these data. We can't blame it all on the seasonals. Breaking it down by industry, it's pretty safe to say

there's wall-to-wall strength. Ian Sheperton, chief economist at Pantheon macroeconomics, said, it seems reasonable to expect a correction in payroll growth in February, but the labor market nonetheless is going to look tight when the Fed sits down in March. The Fed thinks the labor market is too tight and the latest payroll and unemployment data do not change that picture. Still for markets, it's mostly just been confusing. The Kobayisi letter writes the stock market is incredibly confused after the January jobs report. Fed policy expectations changing by the hour, commodities up, stocks are up and down. Data is showing inflation is falling, but the jobs market is stronger than ever. The Fed must be very divided right now.

Former breakdown guest Jared Dillion tweeted, the NFP print was probably bogus due to screwed up seasonality factors, and everyone knows it, including the Fed. But it's the optics of a 500K print that is forcing rate hike expectations higher. This is the reality we live in. And that is really the rub of it. After such a hot jobs headline, the Fed was probably going to be forced to do something. That started on Monday with Federal Reserve Bank of Atlanta President Rafael Bostic, speaking with Bloomberg to pour some cold water on the post-FOMC party. He reiterated his base case from January when he said that the Fed would need to get rates to the forecast 5.1% and hold them there throughout this year and the next. He added that the stronger than expected economy could mean an additional

quarter-point hike beyond the two already penciled in for the next two FOMC meetings. Quote, it'll probably mean we have a little more work, and I would expect that that would translate into us raising interest rates more than I have projected right now. Bostic said he could not rule out a 50-bases point hike at some point along the way, if I economic data continues to exceed expectations. He also raised the possibility of a higher terminal rate than forecast by the FOMC in December. The tough talk appeared to be enough for markets, which began pricing in the Fed's stated rates path, abandoning hopes of rate cuts toward the back of this year. Now, when it came to the jobs report specifically, Bostick echoed widespread skepticism,

stating that Fed officials would need to understand if the jobs report was a, quote, anomalous reading, in which case they would be, quote, inclined to look through this a bit. At the end of the a lot of Bossack's comments were about optionality. He said, I like optionality, so I never want to foreclose any action. But I do think that a lot of this will depend on how the economy evolves relative to my expectations. We understand what data dependence means and we're going to try to avoid getting too locked into just one approach. This obviously continues some of the themes that we've seen from Chairman Powell over and over again, that they're going to continue to fight inflation until the job is done, that they need the Fed to be in the right position to push

inflation all the way down to their 2% target. But that when it comes to specific policy, it's going to be data-driven. He also used this as a chance to reinforce the soft landing narrative. Bostick said, quote, I've said for a long time that I thought there's a lot of momentum in the economy and that there was a good chance that that momentum was going to be sufficient to absorb our policy tightening in ways that could help us avoid a recession. But will this hedging actually continue to contribute to the problem? The Kobayisi letter again wrote, the market has added 25 to 50 basis points in rate hike expectations since Friday, yet stocks are barely able to hold a daily decline even with poor earnings.

This market continues to look for reasons to rally. When markets want reasons to rally, they will usually find them. Now it would be one thing if it was just Bostic that was deployed, but it wasn't. On Tuesday, Minneapolis Fed President Neil Keshkari also joined CNBC and CNN. He made the argument super simply. Strong jobs data means we need more hikes. Keshkari said that the interest rate needs to get. to 5.4%. Remember, that's higher than the December median estimate of Fed members, which was 5.1%

by the end of this year. He did echo some of Bostick's messaging, saying no one should overreact to one report, but he threw even more cold water on the whole thing. He said the underlying strength of the service sector of the economy is still very robust, and that's where I think a lot of us are focusing our attention. I was surprised by the big jobs number. It tells me that so far we're not seeing much of an imprint of our tightening on the labor market. There's some evidence it's having some effect, but it's pretty muted so far. I haven't seen anything yet to lower my rate path. We need to raise rates aggressively to put a ceiling on inflation, then let monetary policy work its way through the economy. We can always back off, so we're having to let

inflation guide policy rather than our models guide policy. Now, in many ways, Bostick and Kashkari are just prelude to the big show, which is Powell giving a speech this afternoon in Washington. In advance of that, markets were cooling to see if Powell would keep this same message up. When Thin at Brown Brothers Harriman said they thought it was a chance to do damage control. Quote, his press conference last week left a lot to be desired. In the wake of strong data Friday, Powell may have to change his tone. Indeed, the biggest surprise to us was that Powell did not push back against recent loosening of financial conditions. Will he course correct or will he simply let the data do the talking forum? Evercores, Krishna Guha says,

we think the Fed Chair will not lurch to max hawkish, but will leverage the employment report to be more credibly hawkish. Thomas Leon Fundstratt, however, are taking the contrarian position and saying that Powell sticks to the dovish script. Their reasoning? Thomas Lee tweets, January reflects seasonal hiring, if December fewer hires than January less. Jobs not corroborated by wage gains and August jobs strong than September softish. Look at the companies, layoffs. Took three soft inflation reports, then fed disinflation, but one job report changes at all? So we will see. Also, worth noting that something like six more Fed officials are planned to speak tomorrow as well, so this will likely remain a busy, dynamic week.

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Now, one quick follow-up from yesterday before we go. Yesterday, we covered what looked like the early stages of a deal being finalized between bankrupt crypto lender Genesis Global Capital and a group of their major creditors. The deal was rumored to include the winding down of Genesis's loan book and the sale of bankrupt Genesis entities, a refinancing of loans made to parent company DCG of around $600 million in cash and Bitcoin, and the equitization of the 10-year promissory note exchanged by DCG for the Three Arrow's Capital claim. When I recorded the show yesterday, it was unclear whether Gemini, who represents the largest

group of creditors, had agreed to this deal. After the show was published, we got more information about Gemini's outlook in a tweet from CEO Cameron Winklevoss. He writes, Today, Gemini reached an agreement in principle with Genesis Global Capital, Digital Currency Group, and other creditors on a plan that provides a path for earn users to recover their assets. This agreement was announced in bankruptcy court today. This plan is a critical step forward towards a substantial recovery of assets for all Genesis creditors. In addition, Gemini will be contributing up to $100 million more to earn users as part of the plan, further demonstrating Gemini's continued commitment to helping earn users achieve a full recovery.

We've been working around the clock since November 16, 2022, to reach this milestone. We greatly appreciate your support and patience during this time. It has allowed us to maximize our efforts on your behalf. There is still much work to be done to complete this process, including further due diligence of Genesis financials and judicial approval of this plan, but we are confident that we now have a framework in place to execute. Thank you for putting your trust in us during this challenging time. So basically what happened next is that all eyes turned to Genesis and DCG to see what they'd be selling.

Andrew at AP Abacus, who's been following the story closely, writes, both Genesis trading and DCG are selling off assets to meet the demands on their agreements with Genesis creditors. Other Genesis lines of business, including CoinDesk and DCG portfolio companies are all in play. End quote. Now, the Financial Times also reported this morning that DCG had begun selling significant tranches of shares in various grayscale trusts. While many quickly jumped at the idea that they might be liquidating GBTC, it seems to have been focused largely on their Ethereum fund. Based on SEC filings, DCG sold around a quarter of its holdings in its Ethereum fund since January 24th. These sales looked to have brought in around $22 million,

but were made at $8 per share, which is half the price of the underlying Ethereum each share represents. When asked to comment, DCG said, this is simply part of our ongoing portfolio rebalancing. Anyways, I would just warn to be extra careful around any claims of something. happening or not. This is a fast-evolving situation, and there are a lot of folks on Twitter who unfortunately are going to be looking for the juiciest headline rather than the best information. I said yesterday at the end of the show that this news was more optimistic than it might otherwise have been, and that continues to appear to be the case. Anyways, guys, that's it for today. I'm sure we will have much more tomorrow as relates to Powell's speech and where the markets are

headed, but for now, I appreciate you listening as always, and until tomorrow, be safe and take care of each other. Peace.