The Breakdown - The ‘Higher-for-Longer’ Fed Reality Hits Markets

Episode Date: August 30, 2022

This episode is sponsored by Nexo.io, Chainalysis and FTX US.   The week ended badly. Equities were down big and over the weekend crypto followed, with bitcoin (BTC) dipping under $20,000 and ether (ETH) losing 14% following Federal Reserve Chair Jerome Powell’s speech Friday at Jackson Hole, Wyoming. On today’s episode NLW explores how the markets are internalizing the reality of a “higher-for-longer” Fed.  - Nexo is a security-first platform where you can buy, exchange and borrow against your crypto. The company safeguards your crypto by relying on five key fundamentals including real-time auditing and insurance on custodial assets. Learn more at nexo.io. - Chainalysis is the blockchain data platform. We provide data, software, services and research to government agencies, exchanges, financial institutions and insurance and cybersecurity companies. Our data powers investigation, compliance and market intelligence software that has been used to solve some of the world’s most high-profile criminal cases. For more information, visit www.chainalysis.com. - 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: Bartolome Ozonas/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 nexus.com, and ftX, and produced and distributed by CoinDesk. What's going on, guys? It is Monday, August 29th, and today we are discussing the reality of the higher-for-longer-fed-hitting markets. 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 breakdown pod. Also, a disclosure, as always, in addition to them being a sponsor of the show,

I also work with FTX. All right, guys, woof, what a weekend. Bitcoin went for a while under 20K, and just in general, it felt like bad news had set in. So let's do a little bit of a macro preview for the week and try to get a sense of why things are a little gloomy. So what set in was in one part the reality coming out of Federal Reserve Chair Jay Powell's Jackson Hole speech. We discussed this a bit on Friday's show, but it was just after the speech and so people hadn't fully internalized the message. The message was succinct.

The speech only lasted for eight minutes. And effectively it stripped all room for interpretation, all nuance, and all hope for a devish pivot to come anytime soon. Restoring price stability, said Powell, will likely require maintaining a restrictive policy stance for some time. The historical record cautioned strongly against prematurely loosening policy. Powell explained that the inflation fight, quote, requires us to use our tools forcefully and elaborated on the ramifications of this stance.

Reducing inflation, he said, is likely to require a sustained period of below-trend growth, While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also cause some pain to households and businesses. These are the unfortunate costs of reducing inflation, but a failure to restore price stability would mean far greater pain. In the speech, Powell didn't mention anything about a softish landing or backing off in any way. Estimates of longer run neutral, he said, are not a place to pause or stop. So the markets over the course of Friday began digesting this reality, the reality of a

Fed that was committed to restrictive rates for longer, a Fed who had essentially flagged that there would be no monetary accommodation despite a recession until inflation eased significantly. By the end of Friday, it was a bloodbath. The S&P 500 was down 3.37% on the day. The NASDAQ 100 was down 4.1%. Paul Christopher, the head of global market strategy at Wells Fargo Investment Institute, said markets must absorb the fact that the Fed is going to remain aggressive until inflation's back is broken. Mac 10 on Twitter said, this will be what I call a brown swan event. What happens when bull's shit a brick because they realize the Fed is not bailing them out for the first time since 2008? Charlie Bilello gives him extra context. The S&P 500 closed down 3.4% today. It's seventh daily

decline of 3% or more this year. In the last 70 years, the only years with more 3 plus down days than we've already seen in 2022, 2008, 2009, and 2020. The contraction is a new time. The contraction in equities was also quite obvious when taking a global view. MSCI's World Index, which tracks large and mid-cap companies over 23 developed market countries, experienced its most severe weekly outflow since the depth of the bear market in June. It reached a one-month low after losing 1.5% across the last week and a 2.6% drop on Friday. The Kobe Ease letter wrote nearly half of the recent relief rally in stocks has now been erased. As the bear market begins its next leg lower, we have set one of the largest bull traps in history.

The reality is that we have a Fed raising interest rates at a rapid pace into a recession. Bumpy wrote ahead. It wasn't just stocks, but also bond markets that adjusted to this new reality, or really the same reality that the Fed has been saying or trying to say that markets just weren't listening to. Bond markets shifted by reducing their bets on interest rate reductions next year. The inversion between the two- and 10-year maturities widened, suggesting that the bond market anticipates a recession being necessary to get price pressure back under control, and two-year Treasury saw their highest interest rate level since 2007, surging to 3.47% on Friday. Connor Sen, an opinion columnist at Bloomberg, said highest level for two-year yield since

early November 2007. And if you're not getting nostalgic for pre-Barristerns, housing, and macro blogs, we are not the same. In times like these, security of your assets should be your number one priority. If you want to offset risk as much as possible and still stay in crypto, you need a trusted partner by your side. Nexo is a security-first company. that manages risk by relying on mechanisms such as over-collateralization, real-time auditing, and insurance on custodial assets. Learn more about Nexo's reliable business model and start your crypto journey at nexo.io. That's nexo.io.

Eager to make more informed decisions around crypto, Chainllysis is here to help. Chainllysis demystifies cryptocurrency by providing industry-leading compliance, market-intecho intelligence and investigations support for all crypto assets. For organizations like Gemini, Crypto.com, and BlockFi. Gain unparalleled visibility and maximize your potential with the leading blockchain data platform by visiting us now at Chainalysis.com slash CoinDesk. The breakdown is sponsored by FTXUS. FtXUS 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 transaction 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 FTCX, you pay no gas fees. Download the FTCX app today and use Referral Code Breakdown to support the show. Now, as has been the case forever, front of mind among policymakers seems to be avoiding a repeat of the disastrous stop-go monetary policy of the 1970s. John Fla Hive, the head of fixed income investments at BNY Mellon Wealth Management, said they do not want to make the mistake of lowering rates and watching inflation go back up. Liz Ann Saunders, the chief investment strategist at Charles Schwab, said once they get to whatever the final hike is, they're going to stay there for a while.

The market had trouble digesting that. Brian O'Reilly, the head of market strategy at Mediolanum, said they don't want to be remembered as the central bank that missed inflation or even spurred inflation higher. Neil Duda, the head of U.S. economics at Renaissance macro research, said, the process won't be painless, and I think Powell's being more upfront about that. The likelihood of recession is rising because that's the solution to the inflation problem. That's what they're telling you. So this was the main catalyst for a really rough weekend, and frankly, today continued the trend. The S&P 500 fluctuated a bit after dropping as much as 1%.

Same with the NASDAQ, which trimmed some declines after falling 1.3%. and basically it was just a recalibration of expectation sort of day. Now, in the center of all of this is a fresh move up in the U.S. dollar. The dollar index sustained levels above 108 all of last week, a level that was only briefly touched in July, and during Sunday trading, the dollar index surged above 109 for the first time since 2002. There is a lot of discussion around this. J.P. Morgan economists forecast that the U.S. will experience the fastest slide in inflation

among developed economies in part due to strength of the dollar. Others are basically seeing the strength of the U.S. dollar exporting inflation around the world. Dylan Leclair from Bitcoin magazine writes, The reality is that the biggest short position in the entire global economy is dollars by a massive margin. The entire world is short and the free float contracts as the economy slows. Sentiment is bearish misses the point. U.S.D assets are forcibly sold to cover the short. Luke Gromond explored some similar themes.

Foreigners owned 17 trillion net 40 trillion gross in U.S.D. denominated assets. They will sell it all if they must raise USDs to, quote, cover their U.S. short position. The U.S. stock market drives marginal U.S. consumption, GDP, and tax receipts. Let's watch. Now, of course, when the dollar goes up, risk assets fall, and that includes crypto. Bitcoin fell below 20,000 on Sunday, extending its fall from Friday trading. Bitcoin went down more than 8% since Jerome Powell's comments, although it is up slightly today. Ethereum followed suit dropping under 1,500, down more than 14% over the $14% over the the weekend. CC Liu, CEO at consulting firm Venlink partners, said money is flowing out of risky assets.

Crypto followed the sharp adjustment of the U.S. stock market. Markets didn't like what he had to say, and Bitcoin is resuming as a high beta asset. Now, this 20,000 level has been pretty key for Bitcoin throughout the summer. It acted as a support level during the June sell-off. Antony Trenschiv, the co-founder and managing partner of Nexo said in a note on Sunday, quote, If Bitcoin doesn't hold 20,000, then 18,900 comes into play before a date with the June intraday low of 17,600. Close below that, and it doesn't look pretty. For now, at least, that doesn't seem to be happening, but it remains a concern.

Also a sign of just where we are right now, there were some random fud things floating around this weekend. There was a rumor that the Mount Gox coins were getting distributed this week, which has been completely debunked. There was also this very strange thing with avalanche, where a quote-unquote whistleblower accused Ava Labs of paying lawyers to hurt competition and keep regulators at bay, a charge which the company has resoundingly denied, and I think the amount of engagement that we've seen in the crypto markets is just indicative of the sentiment out there right now. Now, beyond just the Fed remaining

hawkish and market sliding, there are other big structural things that people are watching. China pessimism continues to dominate headlines. There is a property crisis, a drought causing a hydropower shortage, persistent COVID outbreaks, bank runs, with two additional small provincial banks now having entered bankruptcy proceedings. Despite a solid earning season for Chinese stocks, outflows continue. Wang Ming Li, the executive director at Shanghai Yupu Investment Company, said, these are indeed tough times, and with earnings season wrapping up next week and some of the firms waiting until the last minute to spill the bad news, it's easy to find any kind of excuse to take profit. For some, there doesn't seem to be enough reasons to buy. A Bloomberg survey of

economists expected 3.7% growth out of China for the year, which is a huge shortfall from the 5.5% target set for the year, and even more dire than the 4% forecast made in July. On top of other problems, the Chinese yuan continued its devaluation that has been ongoing for the past two weeks. It reached a new two-year low of 6.9 yuan per U.S. dollar. As this situation has worsened, Chinese policymakers rolled out an additional stimulus plan. China's State Council announced a 1 trillion yuan package around $146 billion USD. The assistance will target infrastructure property and private businesses. 44 billion is targeted at state banks to finance infrastructure projects, and $73 billion is slated for local governments to refinance existing debt.

Caleb Silver, the editor-in-chief of Investopedia, writes, China's struggle to maintain growth even as it stimulates its economy through various monetary policy measures is clearly not convincing investors that it is working. Tavi Koster writes Chinese yuan devaluing again, but this time feels different than 2015. No one cares and only few investors are positioned for it. China's banking crisis will make Lehman Brothers collapse look like a walk in the park. Sophia Horta I Costa also made a dollar connection. She writes, the dollar's unstoppable rally pressures the yuan, which weakens to a two-year low. The People's Bank of China takes steps to keep things stable. It's a balancing act. A weaker yuan

helps exports, but rapid depreciation can stoke capital outflows. So trying to kind of start to some things up, Dylan LeClair writes, Higher Energy, Higher Yield, Strengthening Dollar. Story of 2022 with no signs of slowing down. The Kobayisi letter points out some reasons to be skeptical that we're done. If the bottom is in, it would be four months faster than the average bear market. First bear market to bottom without VIX at 45 plus. A 12% higher low than the average bear market.

Two less relief rallies than the average bear market. This is not your average bear market. Luke Grumman looks at the politics of this. Current geopolitical value, proposition. Russia. I'll help you fight inflation with cheap energy. U.S., the Fed will fight inflation by increasing unemployment. What will global politicians choose? Now, there are some who think that this is all kind of an overreaction. TXMC trades on Twitter wrote Powell said little new yesterday. The market overreacted downward in part because it overreacted to the upside in July after what it thought

was a dovish turn at FOMC. It was wrong. We just watched the same group of participants repricing their misread. Fiena thinks that it's basically just people not paying attention. He writes, All you had to do to be correct on the two biggest macro events in 2022, Russia's invasion of Ukraine and the reversal of the Fed put, was to one, listen to what policymakers and politicians were saying, and two, to believe them. Why was this so difficult? I have some thoughts. The reasons are complicated, but a common thread in both Russia's invasion of Ukraine and the Fed's commitment to tightening combines recency bias with a systematic, contradictory impulse to disbelieve anything government

officials say, irrespective of the facts on the ground. This is killing people's analysis. It's lazy thinking and it's going to leave you in the dust. Yes, politicians try to instill confidence where only doubt should exist, but habitually taking the opposite side of the government's bet doesn't constitute an investment strategy. Travis Kimmel also wrote a little bit about the Fed's role in markets. There are many ways to view the institution. Some look at what they're doing now and think it's a conspiracy designed to crash the markets. And I get that perspective, like I see the data you're using to arrive at that conclusion, and it even tracks kind of. But that's just not how we work in my experience. We're simply too incompetent for grand design, at least so far. It's this cynicism that

makes Americans finger wag at anything that smacks of central planning. And what is a conspiracy if not central planning? I don't buy it. What seems more likely to me is that the Fed is simply our narrative factory. Things happen with economics and with money, many driven by even bigger forces, and we want someone to credit or to blame. And so the Fed provides. Others wiser than my have noted that Fed actions typically follow rate markets. It rarely leads them. The market moves, the Fed follows, and provides the story. The Fed is the hero, and it's also the cat's paw. And it's this way because we demand it. We don't want to believe there's nothing that we can do. We want to see ourselves as having conquered the fates. We've always wanted that, though. It's just who we are.

I think there's a lot of truth in that. But even if there is, when the market reacts or overreacts to a Fed move, boy howdy. When all was said and done, Bloomberg clocked the contraction after Powell's speech at $1.2 trillion in losses. Easy come, easy go, I guess. For now, I want to say thanks again to my sponsors, nexus.com.com. Nexto.i o.o. Chainalysis 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.