The Breakdown - The Fed’s Interest Rate Message Is Clear: Get to 5% and Keep It There

Starting point is 00:00:00 Of the more than $6 trillion in U.S. government spending last year, almost half a trillion was spent on interest payments to debt holders, an increase of $100 billion compared to 2021. Interest payments to private investors have now become such a significant part of government spending that increased interest rates could have a stimulative effect via increased government deficit spending. Just another example of how weird and uncharted some of these waters are right now. 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.

Starting point is 00:00:41 What's going on, guys? It is Tuesday, January 10th, and today we are going macro and talking about the latest comments out of the Fed. 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 in the show notes or go to bit.ly slash break. down pod. All right, friendos, well, today I wanted to dig into a bit of a macro day. And quickly before we do that, over in Crypto Land, just to give a brief update, there are only a few notable stories, which are kind of more along the lines of the same things we've seen over and over again this year. The headliner is that Coinbase is letting go of about 20% of its employees, around

Starting point is 00:01:22 950 people. This is the third round of layoffs at Coinbase since the bare market began. Last June, it cut 1100 jobs, which is 18% of its workforce at the time. Then in November, it let go of another 60 people. I will say clearly that layoffs suck. CoinDesk estimates that 27,000 crypto employees have been laid off since the bear market began, and that's 27,000 people whose time and talent we don't necessarily have access to anymore. At the same time, taking a wider view of Coinbase, I don't think this is a sign of weakness necessarily,

Starting point is 00:01:52 but just a recognition of the market reality everyone faces. The company staffed up significantly during the last bare market, from around 1,200 people to more than 5,000 employees. That's a move that CEO Brian Armstrong said in retrospect was them growing way too fast. Now, when it comes to this set of layoffs, Armstrong told CNBC that after looking at various stress tests for their annual revenue, quote, it became clear that we would need to reduce expenses to increase our chances of doing well in every scenario. As painful as it is in the short term, I would definitely much rather have consequences. companies make hard decisions to make them stronger and more resilient, then on the other hand, underestimating the bare market and getting into more serious institutional failure territory later on.

Starting point is 00:02:35 A second, big update from Crypto Land, another member of Sam's inner circle at FTX has met with prosecutors and is looking to cut a deal. According to a Bloomberg report from last night, former head of engineering at FTX, Nasjad Singh, attended what's called a proffer session last week, which is basically a session where someone is granted limited immunity to share the information they have with prosecutors on the path to potentially cutting a deal. As Bloomberg puts it, quote, A proffercession doesn't automatically lead to a cooperation agreement. Prosecutors must weigh the value of Singh's information before deciding whether to offer him a deal

Starting point is 00:03:06 that could see him plead guilty and cooperate in exchange for possible leniency. Remember, not everyone who wants a deal can get one done. It's a little bit first come, first serve, and as it stands, Caroline Ellison and Gary Wong have already cut deals around the FTX fiasco. Still, Nishad was pretty involved in the political side of things as well. maybe more than Carolyn and Gary, and that could be valuable. Neshad gave $9.3 million to Democrats since 2020, and increasingly it appears that the political parts of the case are a growing concern for prosecutors. Overall, the big things it shows just how isolated Sam is heading into his trial later this year.

Starting point is 00:03:41 Lastly, a third and final update, which we'll probably get farther into in the week to come. As I was putting the finishing touches on this report, Cameron Winklevoss dropped another open letter demanding that Barry Silbert be removed as CEO of DCG, which also threw around the F-word fraud pretty liberally. But now back to the macro. And on the macro side of things, the big questions this year aren't too far from the big questions last year. They come down largely to, one, what the Fed is going to do. Will they keep raising rates?

Starting point is 00:04:10 How high? And for how long will they keep them there? And then, two, how might the possibility of a recession change those plans? The message from the Fed on this has not been inconsistent. They keep saying higher for longer. The issue is that the market doesn't seem to be buying it, at least not fully. Well, yesterday and today, we got more commentary from Fed officials, some of the first of this year. And to take a step back just a little bit, what we're working

Starting point is 00:04:32 with is that, obviously throughout the last year, the Fed was aggressively hiking interest rates. From June of last year, the Fed pumped four straight hikes of 75 basis points. The first downshift in the speed of tightening came in December with a 50 basis point hike, which is still quite high by historic standards. All told, last year saw one of the fastest hiking cycles in the history of the Federal Reserve, with rates moving from zero to 4.5% over the space of just nine months. Now, the question is whether, as inflation moderates, the Fed will pause? Or if a recession starts to take hold, will they actually pivot? Throughout a lot of last year, Fed officials appeared to be operating in near-lockstep. However, by November and December, there did appear

Starting point is 00:05:11 some cracks. In November, reporting from Nick Timrose of the Wall Street Journal suggested that there was an increasingly factional divide between hawks and doves at the Fed. Doves were pushing for a more cautious approach to further rate hikes, noting that monetary policy operates with a lag that could take some time to feed through the economy, while Hawks were still focused on the threat of ongoing inflation. It appears based on today's comments that Chairman Jerome Powell has done some work to unify the doves and the hawks around the policy aim of getting interest rates above 5% and holding them there for a substantial amount of time. Speaking at the Atlanta Rotary Club on Monday, Atlanta Fed President Rafael Bostick said that in his opinion, the Federal Reserve should

Starting point is 00:05:49 raise interest rates above 5% by early in the second quarter and then hold them there. He stated that the current high inflation in the U.S. warrants additional rate hikes in order to squeeze excess demand out of the economy. When asked by the moderator how long he anticipates needing to hold rates above 5%, Bostic answered three words, a long time. I am not a pivot guy. I think we should pause and hold there and let the policy work. In addressing the risk of holding Fed policy too tight for too long, Bostick said that it's, quote, fair to say that the Fed is willing to overshoot. Now, speaking with the reporters after the event, Bostick noted that if Thursday's CPI report shows cooling inflation below expectations to match last week's job report which showed

Starting point is 00:06:27 slowing wage growth, then the case for reducing the size of the Fed rate hikes to 25 basis points will be strengthened. Quote, if the CPI comes in showing the same kind of trending that we saw in the jobs number, that will make me have to take 25 more seriously and to move in that direction. But we still have some time to go before that. Another Fed official also spoke. San Francisco Fed President Mary Daly concurred in a live stream interview with the Wall Street Journal, which also happened on Monday. Daly said that she expects the Fed to raise rates somewhere above 5%, although the ultimate level is unclear and will be determined by incoming inflation data.

Starting point is 00:06:59 President Daly held the opinion that there was a strong case for further reducing the size of rate hikes, saying, doing it in more gradual steps does give you the ability to respond to incoming information. She also stressed that it's too early to declare victory over persistent inflation. Last month, President Daly pushed back on the market, which had been been pricing in rate cuts toward the end of this year, by saying that she views holding the federal funds rate at its peak for 11 months as a, quote, reasonable starting point. The next FOMC meeting will take place at the beginning of February, with markets currently pricing in a 25 basis point

Starting point is 00:07:29 hike as an almost 80% likelihood. Importantly, these expectations have significantly contracted over the past month. At the start of December, markets were pricing in a 50 basis point hike in February as an almost 50% chance. While longer range market expectations are much less accurate, they could be telling in this instance. The highest probability expectation is that the Fed will hike by 25 basis points in both February and March before putting rate policy on pause until the end of the year. This would fall just shy of reaching a 5% terminal rate. With that market expectation on the board, this could explain the strong and coherent message from Fed speakers this week. Officials may believe that they need to convince markets of their resolve to get rates above 5%

Starting point is 00:08:08 and hold them there, especially in light of concerns of quote, an unwarranted easing in financial conditions expressed in December's FOMC minutes which were released last week and the subject of one of the breakdowns later in that week as well. Equity markets responded strongly to this jaw-boning from Fed speakers. The S&P 500 erased a 1.4% gain from the morning session to close the day close to flat. Tebow Capital tweeted, this is an incredibly hawkish comment from Bostick, and yet the market is still in rip mode. The market only cares about what Powell has to say. If Powell sounds even remotely like Bostick tomorrow, look out below. Nadine Terman, the CEO of Solstine Capital, says nothing like Fed speak to reverse markets. Daly and Bostick talked about rates above 5%

Starting point is 00:08:48 and holding that level. So expect continued chop, even if CPI on Thursday shows inflation slowing. Merlin Capital writes Fed Daily just made it clear what the Fed is going to grade on inflation progress, core inflation and they believe it's ingrained. You can see the market was not expecting that. Zay Capital said all these Fed speakers talking about holding rates at 5 plus percent through 23 are all assuming it's a soft landing, leading indicators screaming otherwise. Lastly, Michigan-off writes, not sure why the Fed bothers with policy when they can just send out an endless stream of speakers. I would say here that one of the reasons it's worth covering these speakers is that they're not

Starting point is 00:09:21 just people who share information about Fed policy. They are part of Fed policy. If the Fed could get the market to do what it wanted just through suggestion and influence, it would never have to change rates at all. The Fed uses speakers to drive markets in the direction that rate changes would have them head as a way to reduce how aggressive their policy shifts have to be. So remember, when we're looking at what Fed speakers say, we're actually reviewing a tool of Fed policy, not just a review of it.

Starting point is 00:09:47 Speaking of Fed speakers, Powell also spoke this morning. He was on a panel discussion in Stockholm, and this was another speech in line with what we've seen, where Powell says something along the lines of, even if this isn't politically popular, even if the market thinks there'll be too much pressure on us to back off, we are sticking with it. Price stability, he said, is the bedrock of a healthy economy and provides the public with measurable benefits over time. But restoring price stability when inflation is high can require measures that are not popular in the short term, as we raise interest rates to slow the economy. Now, it really wasn't much of a speech, but the conference appropriately was on central bank independence.

Starting point is 00:10:22 And interestingly, Powell also pointed out that having independence means that mandates need to be tightly defined. He pushed back against the idea, for example, that the Fed should be overly involved in the climate discussion. And this is the quote that's making the most hay right now. Without explicit congressional legislation, he said, it would be inappropriate for us to use our monetary policy or supervisory tools to promote a greener economy or to achieve other climate-based goals. We are not and will not be a climate policymaker. Join CoinDesk's Consensus 20203, the most important conversation in crypto and Web3,

Starting point is 00:10:58 happening April 26 through 28th in Austin, Texas. Consensus is the industry's only event bringing together all sides of crypto, Web3, and the Metaverse. immerse yourself in all that blockchain technology has to offer creators, builders, founders, founders, brand leaders, entrepreneurs, and more. Use code breakdown to get 15% off your pass. Visit consensus.coindesk.com or check the link in the show notes. Now one other note on the Fed. To the extent the conversation is around whether the Fed can hold their conviction, there is a new narrative reason popping up why they might not be able to. One of the interesting notes to bubble up from the fringes of FinTwit over the Christmas break

Starting point is 00:11:43 was the fact that the Federal Reserve is now losing money on its operations for the first time since 2011. A chart of Fed earnings, which are remitted to the Treasury, became a popular doom chart over the winter, and it looks atrocious. Previous losses were in the range of a few hundred million dollars per week and only sustained for a week or two at a time. Under current policy settings, the Fed could be facing up to $100 billion in losses next year. Where does this money go? The losses are almost entirely attributable to the interest the Fed pays commercial banks to warehouse reserves at the central bank.

Starting point is 00:12:13 Since those interest payments became a part of Fed policy in 2008, this has never before been a major issue as interest rates were held extremely low. This year, amid rising interest rates, the Fed is now paying commercial banks 4.4% simply to hold reserves. While the financial plumbing aspect of this is keenly debated, specifically whether or not these reserve holdings compete with the commercial lending activities of banks, the macroeconomic implications of handing over massive interest payments to commercial banks is not well understood. Some are suggesting that it could act as an additional form of fiscal stimulus, albeit concentrated

Starting point is 00:12:43 entirely in the commercial banking sector. Others are pointing out that this stimulative effect should be entirely counteracted by the Fed's ongoing quantitative tightening policy. So is this a problem? Will the Fed go broke? The last bare standing put it well in a substack article from early December stating, quote, Fed losses are not a quote unquote problem in a practical sense, Unlike a commercial bank, the Fed can't go broke. It can always print. Therefore, the Fed's losses are the private sector's gains. Specifically, more money is created and paid to commercial banks and RRP participants, increasing commercial bank capital and providing income to money market funds. Ironically, this monetary stimulus is a result of the aggressive rate hikes of the Fed,

Starting point is 00:13:22 and the higher rates go, the larger this effect will be. End quote. He highlighted that the main issue appears to be the loss of revenues to Treasury, who will no longer receive remittances from a profitable federal reserve, and could be forced to issue more debt to backfill this loss of revenue. Modern monetary theory or MMT commentators have been noting this point for years. With U.S. government debt at nosebleed levels, interest payments on government debt form a major part of total government expenditure. Of the more than $6 trillion in U.S. government spending last year, almost half a trillion was spent on interest payments to debt holders, an increase of $100 billion compared to 2021. Interest payments to private investors have now become such a significant part of

Starting point is 00:13:59 government spending, that increased interest rates could have a stimulative effect via increased government deficit spending. Anyways, this is getting a little bit wonky for this show, but just another example of how weird and uncharted some of these waters are right now. Now, the hawkish tone of hire for longer that we see coming from the Fed is not just a U.S. phenomenon. Bloomberg Economics forecasts are expecting that of the 21 jurisdictions they monitor, 10 are expected to continue hiking rates this year, with 9 projected to cut rates and another

Starting point is 00:14:29 to hold steady. Overall, this leads to an expectation that Bloomberg's global rates gauge will peak at 6% in the third quarter of this year before moderating slightly to close the year. That would be the highest level since 2001 and up from the 5.2% shown at the start of this year. Tom Orlik, the chief economist at Bloomberg economics said, in 2022, with inflation high and rising, there was only one way for central banks to go, and the biggest mistake investors could make was not factoring in enough hikes. In 2023, with inflation, high but falling in recession looming, tradeoffs are starting to bite. Risks of the policy path are opening up below as well as above.

Starting point is 00:15:06 And Awang, staff economist at Bloomberg said, We expect concerns over inflation will keep the Fed hiking rates until the upper bound reaches 5% by the end of the first quarter. With inflation expected to remain in the vicinity of high 3% level in 2023, the Fed will likely hold rates at that peak level throughout the year in order to keep real rates above in restrictive territory, even as a mild recession is likely to develop in late 2023. overall, economists polled by Bloomberg currently expect December's CPI data, which again is out on Thursday,

Starting point is 00:15:35 to show that annualized headline inflation has moderated to 6.5% falling from 7.1% in November's data. That will, of course, be the next key piece of information for the Fed to absorb as it figures out what to do in February. So that, guys, is the central bank and Federal Reserve story from where I'm sitting. There is a lot more going on in the macro right now, and I'm sure we'll return to this, if nothing else at the end of this week after we get December CPI data. For now, I want to say thanks for listening, and until tomorrow, be safe and take care of each other. Peace.

The Breakdown - The Fed’s Interest Rate Message Is Clear: Get to 5% and Keep It There

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