The Breakdown - The Macro Landscape Right Now

Episode Date: March 25, 2024

NLW delves into the state of the macro landscape from the Bank of Japan, China, the Fed and more. Today's Show Brought To You By Kraken - Go to https://kraken.com/thebreakdown and see what crypto can be Ledger - 5% to Bitcoin Developers When You Buy https://shop.ledger.com/pages/bitcoin-hardware-wallet Enjoying this content? SUBSCRIBE to the Podcast: https://pod.link/1438693620 Watch on YouTube: https://www.youtube.com/nathanielwhittemorecrypto Subscribe to 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? Today we are talking macro going a little bit wider than we normally do. 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. All right, friends, well, as you know or will have heard on some other episode, this week we are

celebrating my wife's 40th and her mom's 70th birthday, and thus are doing some international travel. Partially then you will get a few really fun interviews, but I'm also doing a couple of pre-planned shows, taking a chance to look at some things that often get shunted and pushed away with all the crazy crypto news at the beginning of this bull market. Today, for example, we are going to look at the macrosphere and even go a little bit beyond the Fed. Now, if you didn't listen to my Fed show last week, the TLDR is that Powell did nothing. But in this case, doing nothing was actually a little bit unexpected. People had thought that perhaps, with a slight resurgence or stickiness of inflation, let's say,

that we might hear a more hawkish tone from Jerome Powell, but that's not really what we got. In effect, he sort of seemed to shrug off this last couple set of numbers. And in some ways, it felt like he was saying, in the same way they didn't get too excited at the end of last year, when numbers were looking better than they had anticipated, they also weren't going to freak out and get all stressed when numbers weren't looking as good as they anticipated over the last couple months. Markets were reassured that the Fed is still projecting three rate cuts this year, but overall, the message was proceed as you have been doing. That said, while the last year of Fed rate policy has been a little sleepy, the Bank of Japan

has finally woken up from its long slumber. Last Tuesday, the BOJ raised rates for the first time since 2007. Japanese rates are now set between 0 and 0.1%, finally bringing an end to the last negative interest rate in the world. The BOJ has been the last central bank to act during this hiking cycle, lagging more than 18 months behind the Fed and the ECB. For those who are unfamiliar, let's do a quick recap of the strange history of BOJ policy. The central bank was the first in the world to drop its interest rate to zero way back in 1999. They were also the first to introduce quantitative easing or QE in 2001. QE is when a central bank purchases government bonds from the market in an attempt to stimulate growth. As listeners of this show will well know, both of these policies

were replicated globally as emergency measures in the wake of the global financial crisis. After 2008, these emergency measures became permanent in Japan and the BOJ expanded the scope of QE buying up corporate debt. By 2013, with no sustained recovery in the Japanese economy, the BOJ upped the ante, announcing a program they called qualitative easing or QQEE. the central bank would begin buying stocks and real estate trusts. Overall, Japan conducted two dozen rounds of QE with minimal impact. In 2016, the BOJ took interest rates negative and began yield curve control. When conducting QE, the central bank targets a certain value of assets to accumulate over a period of time. Under yield curve control, the central bank pledges to buy

an infinite amount of government debt if it rises above a target interest rate. If we're thinking about QE as money printing, then the BOJ is the world's most prolific money printer. But it was all seemingly to no avail. The Japanese economy was stuck in deflation for decades, and none of these central bank policies achieved a sustainable recovery. In 2021, with inflation running hot all across the globe, Japanese inflation began rising as well. The result was strange. Prices were sustainably rising for the first time in living memory for a large portion of the population. Workers were asking for wage increases for the first time in their careers. For all of 2023, the BOJ allowed inflation to run at 3%, scorchingly hot for Japan. There were a large number of interventions along the way,

but they were aimed at protecting the yen, which had devalued by 30% against the dollar. So, with the groundbreaking BOJ decision last week, Japan has finally ended some phase, at least, of their monetary policy experiment. Alongside a slightly positive interest rate, the yield curve control program has been scrapped, allowing government debt to trade freely for the first time in almost a decade. The BOJ has pledged that they will continue buying longer-dated government bonds on an ad hoc basis, but this appears to be a liquidity support measure. At this stage, the BOJ owns over half of Japanese government debt, so there's likely some need for a transition period. It will take quite a long time before BOJ policy can be viewed as normal, but they have now

taken the first step towards normalization. Governor Yueda, who took over as head of the central bank last April, said, primary policy instrument to manage the monetary policy from now on will be short-term interest rates. Thus, the appropriate levels of rates will be set in line with the price and economic outlook. This may seem to you to be a strikingly normal statement for a central bank governor to make, but after decades of failed monetary experiments, it's a relief to many. And this was the mandate that Eweida was appointed under. He's the first academic economist to be placed at the head of the BOJ in its entire 141-year history. During his confirmation hearing in parliament, Uaida said, my mission isn't to come up with some kind of magical special monetary policy.

And that statement alone makes him a far cry from his predecessor, Governor Corota, who set himself the task of achieving 2% within a few years when he was appointed back in 2013. By the end of his 10-year term, Corota was known for his shock and awe tactics. He would often direct B.OJ traders to buy bonds without announcing his intentions to the market, catching traders offside in an attempt to scare them out of pushing rates higher. These tactics achieved little other than frustrating market participants. Although Uyeda has now brought Japan out of negative rate territory, the job of policy normalization is still a massive one. His sites are currently set on maintaining the 2% inflation target. After that, he has expressed the desire to figure

out how to unwind the BOJ's bloated balance sheet. So far, the reviews seem very positive. Hiroshi Miyazaki, a senior economist at Mizuho Research and Technology, said, Uy has done better than Bernanke so far without triggering something equivalent to a taper tantrum. Still, it's not over yet. There are a mountain of tasks ahead of him. Now, why does this matter for people outside of Japan? As the BOJ's interest rates have been sustainably lower than the rest of the world for almost a decade, there has been a huge arbitrage available. Many large investment firms take loans to nominate it in yen to fund their operations and take advantage of the tiny rates. This is admittedly much less common since the yen began

devaluing, forcing a huge unwind of this funding. Still, Japan is in many ways banker to the world and plays a key role in global liquidity. The BOJ, in other words, plays a key role in setting the cost of capital for the financial world, and that cost is beginning to go up. As a related issue, this rate hike is not just about high inflation in Japan. It's also about stabilizing the yen. The yen is down 7% so far this year and has continued to fall since the BOJ hike. Some are viewing the BOJ's actions over the past year as fighting to stave off a currency crisis and have come to the conclusion that the BOJ isn't doing enough. If the BOJ can't stop the yen from falling, the ripple effects as long-term positions blow up could shock global markets. Today's episode is brought to

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of recent years are improving. There's still the massive question mark of how to resolve bankruptcies of some of the largest real estate developers in the world, but for now, that issue seems to be on hold. The places that are showing signs of positivity are in the manufacturing sector. Chinese factory output and investment growth are up to begin the year, giving some renewed hope. Industrial output is up by 7% since last year. Fixed asset investment has risen by 4.2%. Retail sales are growing at a 5.5% pace, but some are concerned this return to growth may discourage the Chinese government from providing additional support. Michelle Lam, greater China economist at society, Hanaral, said, with the recovery in these data, policymakers will likely not see the need to do

more than what they plan to do. She said it would take a much bigger slowdown to encourage authorities to focus on stimulating household income and spending to support consumption. Earlier this month, the Chinese government announced a 5% growth target the same as last year. In 2023, this target was reached, but it was building off the back of a dismal previous year and supported by large stimulus spending. Many analysts are puzzled how the government plans to hit 5% growth without those tailwinds. Even the Chinese Bureau of Statistics is questioning how this will all work, commenting alongside their last data release. The economy kept rebounding and improving in January and February, with various policies taking effect. But we also need to see that the external environment

is increasingly complex, grim, and uncertain. And the problem of insufficient domestic demand still remains. The recent strength it appears is driven by an increase in exports as global trade picks up. Chinese exports rose by 7.1% over the first two months of this year, far beyond expectations. exports, though, do nothing to solve the long-term structural issues in China associated with a lack of domestic demand. Over recent years, the Chinese government has expressed a desire to rebalance the nation's trade balance and begin the long transition to a consumption-based economy. So far, these numbers suggest it will just be more of the same. Economist Changshu wrote, It's a still patchy picture. The growth in private investment was

marginal and consumption slowed and undershot expectations. The bottom line, the recovery is fragile and requires more policy support. One of the biggest gaps in the Chinese recovery is the lack of foreign investment. Over recent years, both financial and industrial investment in China has become a much more risky bet for Western firms. Last year, saw overseas investment hit a record low. The government released a 24-point plan to boost foreign investment late last year, but global CEOs are cautious citing promise fatigue. A large number of the measures include an opening up of investor access. These strategies range from free trade zones for high-tech industry to inclusion in the domestic financial system, such as the ability to underwrite domestic bonds.

The message seems to be that after several long years, China is once again open for business. Question will be whether there are any takers this time around. We're not getting deep into it here, but it is certainly worth noting that in one of the most significant economic sectors in the U.S. right now, both from a practical and a narrative standpoint, to which I'm, of course, referring artificial intelligence, shows why CEOs might be a little bit less willing to invest in the Chinese economy right now. The U.S. government has on a pretty steady clip been ratcheting up, export controls on advanced chip manufacturing for China, and that doesn't seem to be getting anything but more stringent over time. What about Europe? Well, in Europe, both Germany and the U.K. have registered a recession during the second half of

last year with an unclear path back to growth. Between Brexit, double-digit inflation, and political dysfunction, the issues in the UK need little explanation. Or at least we've covered them a little bit more here, so let's give a little bit more focus to Germany. Over the past decade, the German economy has been the industrial powerhouse of the region. Their strong manufacturing and chemical sector has provided the ballast to keep the European economy moving forward. The German manufacturing sector has now been shrinking for several quarters in a row. A huge amount of layoffs are being reported and significant chunks of the industry are being relocated to places like Texas and Mexico. Beginning to look like a slowdown is changing into a permanent deindustrialization.

In Chemicals, the German industry champion BASF has suffered a tremendous downturn. Its sales were down 21% last year with a 60% drop in earnings. Company has already cut 2,600 employees around 8% and plans another round of layoffs this year as the business continues to contract. The key issue is that the chemicals industry was geared towards utilizing cheap natural gas supplied by Russia. Replacement supply has been much too expensive to continue operating in the same manner, with many processes taken offline. Frontier views, Martin Belchev said, The German economy is facing enormous challenges. It lost cheap energy from Russia, flourishing sales markets in China, and an almost free security guarantee from the United

States. With six months of falling GDP on the books, this quarter looks no better. Current forecasts are for another drop in GDP extending the recession out to nine months and counting. The Economic Ministry said in its March report, despite positive trends in industrial production, construction and foreign trade at the start of 2024, a noticeable economic recovery isn't yet in sight. This is due to continue weak domestic demand, high financing costs, and the still subdued sentiment among private households and companies. The expected growth for this year is currently sitting at just 0.1%. That concurs with the ministry's assessment, who warned, a noticeable economic uptick isn't expected until later

in the year as inflation rates continue to fall, wages and incomes rise, the labor market remains stable and impetus from foreign trade increases. At this point, you might be feeling like compared to some of these issues abroad, problems in the U.S. seem kind of trivial. Indeed, the biggest macro question right now is whether the Fed has done enough to slay inflation once and for all, or whether we might be entering a 70-style inflation crisis with multiple waves. Currently, inflation is still above 3%, stuck in an uncomfortably high range for the last eight months. Last week's Fed meeting offered no solutions, with a Dovish Powell, content to wait and see. As I discussed at the beginning of this show, last week's Fed meeting offered no solutions.

Marco Kulinovich, the chief global market strategist at J.P. Morgan recently wrote, believe that there is a risk of the narrative turning back from Goldilocks towards something like 1970s stagflation, with significant impacts for asset allocation. So what were the main market features of the 1970s? Perhaps the most important is high inflation that came in three separate waves, all in some ways related to geopolitical developments. Though geopolitical developments included significant proxy wars in Southeast Asia, i.e. Vietnam, several wars and revolutions in the Middle East, oil embargoes resulting in energy crisis, shipping disruptions, and an increase of deficit spending in the rise of interest payments on government, corporate, and

debt were a significant drag on the economy in the 1970s. Equity markets were essentially flat from 1967 to 1980 in nominal terms, and bonds and credit outperform significantly. Elsewhere on the note, Kolnovich discussed another similarity to the inflationary period of the 70s as global tensions drove a wave of de-globalization. He argued that we could be seeing an unwinding of the positive feedback loop of the past three decades, as the end of the Cold War drove an increase in global trade and resulted in declining interest rates and inflation. Kulinovich wrote, it is easy to see this feedback loop going into reverse, decoupling of global trade, supply chains, and economies that is leading to higher inflation, possible energy and trade disruptions, or even

hot wars, and growing fiscal deficits leading to higher interest rates, economic slowdown, and lower asset valuations. Economist Larry Summers recently grappled with the idea that U.S. inflation during the past three years was actually much worse than the number suggested. He noted that using the pre-1983 method of calculating CPI, the inflation spike in November 2022 would have measured at 18% rather than the reported 4.1%. Currently, inflation metrics do not include borrowing costs for housing and car loans as they did in previous eras. There's a good reason to exclude these factors as they shift in the same direction as Fed rate hikes, leading to a never-ending feedback loop. But the issue, according to Summers, is that by excluding the

cost of borrowing, the data doesn't fully reflect the inflation pain felt by households. Summers wrote, when interest rates jumped last year, official inflation did not fully capture the effects it would have on consumer well-being. Summers noted that personal interest payment, if included in the CPI, would have shown a 50% inflation rate for that category of household costs. One of the key drivers of inflation over the past few years has been energy costs. If we're going to see another wave of inflation, it's likely to show up there first. Since the beginning of December, oil prices have increased by 10% and are now sitting above $80 for the first time in five months. We're beginning to hit a patch of volatility so the price may be

overextended into weakening global demand, but the trend is still alarming. Another round of production cuts from OPEC suggests that supply will be kept tight, but added production outside of the cartel has prevented the price from running away. Attacks on shipping through the Red Sea and drone strikes on Russian refineries have disrupted supply on the margins, adding to price volatility. Lastly, today, one of the big assumptions of the current macro environment is that we can predict what a normal U.S. economy will look like, but it's worth asking the question, I think, what if we simply can't? During the past decade, quote-unquote normal has been growth at around 2%, inflation struggling to get to 1%, and rates near zero. At the moment, rates are above 5%,

growth has come in at nearly 6%, and inflation is moderated to between 3 and 4%. What if that's simply as good as it's going to get for now? It's not that far away from the conditions coming out of the 1991 recession, and that period is viewed as one of the better economies in U.S. history. During last week's Fed meeting, Powell was asked about longer-term rate projection shifting upwards and what that might indicate. He responded, in terms of, are rates going to be higher in the long run? I don't think we know that.

We think that rates were generally low during the pre-pandemic post-global financial crisis era for reasons that are mostly important, slow-moving things like demographics and productivity. My instinct would be that rates won't go back down to the very low levels that we saw, where all around the world there were long-run rates that were at or below zero. I don't see rates going back down to that level, but I think there's tremendous uncertainty about that. So friends, that is our little tour of the macro environment right now. Hopefully this was useful, slight departure from our normal content. Today, all that is left, though, is to say thank you one more time to the sponsors of today's show.

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