The Breakdown - What the CPI Says About The Fed's Next Moves

Episode Date: September 13, 2024

Everyone in markets is confused about everything it seems. NLW explains the latest CPI numbers; what they mean for the upcoming FOMC meeting; and what it means for Bitcoin. 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? It is Thursday, September 12th, and today we are talking CPI. 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. All right, friends, well, August inflation data came in, and it came in slightly above expectations, adding complications to next week's Fed rates decision. Headline CPI rose 0.2% for the month, the same as July,

and broadly in line with inflation targets. This brought the 12-month headline inflation rate down to 2.5%, which is a significant reduction from the 2.9% reading in July, and the lowest level since February 2021. We've now had four months in a row where headline inflation looks fairly under control. Monthly figures suggest it's still running above 2%, but not by much. The problem was in core CPI, which strips out food and energy costs. The core reading came in at 0.3% for the month, which was slightly above expectations. This puts 12-month core inflation at 3.2%, which is the same as last month, and which shows signs of stickiness. The Fed doesn't use the raw CPI data to guide their decision-making. Instead, they use PCE inflation, which uses CPI figures as an input.

PCE inflation is typically around 0.4 percentage points below CPI inflation, so we're still close to target, but progress seems to have stalled out. Seema Shaw, chief global strategist at Principal Asset Management said, this isn't the CPI report the market wanted to see. With core inflation coming in higher than expected, the Fed's path to a 50-bases point cut has become more complicated. And this is really where the discussion is. The CPI number is certainly not an obstacle to taking policy action next week. But it's likely that the hawks on the committee will seize on the CPI report as evidence that the last mile of inflation needs to be handled with care and caution, which is a formidable reason to default to a 25 basis point reduction.

To boil down the inflation print to a single explanation, it's housing. Shelter is one-third of the index and rose 0.5% for the month. This was the largest monthly increase so far this year and accounted for 70% of the CPI increase overall. It was also the first time, shelter inflation has accelerated since March. Over the past 12 months, shelter costs are now up 5.2 percent, more than twice the overall pace of inflation. There is, it should be noted, a lot of skepticism around the way housing inflation is measured. The Fed uses a combination of rental averages and owner's equivalent rent, where homeowners estimate how much they could rent their house for. The metric is laggy and often overstated, and make shelter inflation alone a very thin

premise for the Fed to hold back on their rate cuts. Former Chair of the Council of Economic advisors, Jason Furman wrote, Core CPI came in above expectations in August, driven by an unusually large increase in shelter prices. The August increase is much larger than what is likely in coming months. Nevertheless, each month of data reinforces my view that there is less to the inevitable fall in lag shelter than many have argued. Inflation was basically non-existent in CoreX shelter. The Fed targets PCE, but won't get the August number until after the next meeting. Based on this release, core PCE should come in at 0.2%, not annualized. Below the 0.3% core CPI, mostly because shelter plays a smaller role. Remains below the pace expected by the Fed CEP in June. Overall,

this is a bit of a disappointment, but maybe even more than usual would not update much, especially given the large disconnect between the CPI and the PCE. Nevertheless, it is another nail in the coffin of a 50-point basis cut next week. Now, this point that inflation is basically non-existent aside from housing is worth drilling into. Core CPI without the shelter component is currently running at a 1.1% annualized rate. Core Services is a little hotter at 2.9%, but that metric does usually run above overall inflation. It's entirely possible, then, that the Fed will view hot shelter inflation as a one-off anomaly and discount its importance.

There's also the point that the Fed is somewhat out of tools to get shelter inflation down any further. The Fed can't build more housing, they can't drive rent reductions, and they can't force people to downsize. All they can really do is jack up interest rates to make more construction activity and new mortgages more expensive. That's been the policy setting for over two years, and it's questionable whether there is any further progress to be made. Still, everyone is impacted by housing inflation, so it's a little

hard to call the inflation fight truly over until runaway inflation and shelter comes down. We could also see the Fed emphasize the point that short-term inflation metrics are extremely low. Over the past three months, core CPI is running at a 2.1% annualized rate. That means the PCE inflation is steadily below target on a short-term basis. Markets ratify the sentiment that a double cut was off the table for next Wednesday's Fed meeting. Fed Fund's futures are now pricing the chance of a 50-bases point cut at 13% down from 34% prior to the inflation print. Bloomberg columnist John Authors highlighted how wildly market sentiment has been swinging,

writing, round trip completed, the Fed Fund's futures odds on a 50 basis point cut next week are now exactly where they were when the market opened on August 1st at 13%. The latest round of data makes it very hard for the FOMC to start that aggressively. Another takeaway is that it appears that inflation fears have completely subsided. inflation break-evens and market-based estimate of long-term inflation have plummeted. Markets are now pricing inflation at 2% over the next 10 years, the lowest level since 2021 and down dramatically from the high of 3% in mid-2020. Joseph Broussela, the chief economist at consulting firm RSM-US, said,

My sense is that underlying inflation is moving along at a 2% plus pace. With break-evens at near 2% and the one-year swap below 2%, firms can now begin making investment and expansion plans in ways they have not been able to over the past five years. Overall, risk assets traded soft on this inflation print. Bitcoin fell by 1.8% in the hour following the release, but ended the day slightly up. The S&P 500 suffered a 1.8% drawdown at the open, while the NASDAQ dropped by 3.4%. Both indices rallied into the afternoon and closed the day firmly in the green. Dwindling chances of a jumbo-size cut next week seemed to be the obvious driver, but markets seem to lack a clear direction. Meanwhile, Quinn Thompson, the CEO of Lucker

Capital thinks it's all just noise. Today, he tweeted, might have been the most mental gymnastics I've seen around one completely meaningless inflation report to try to assign a bearish narrative to lower asset prices. Hello, friends. Before we get back to the rest of the show, I want to implore you to join me at Permissionless. Permissionless is the conference for crypto-natives by crypto-natives, and the reason it's so important this year is that despite regulators' best attempts to push industry founders, devs, and executives out of the U.S., the United States remains the beating heart of crypto. Today, the tide is turning. Policymakers have pivoted from fighting crypto to

embracing it. Literally now we are in a major political parties platform, which will lead ultimately to the creation of new financial products, new applications, and ultimately new adoption. Permissionless is the conference for those using and building on-chain products. It's home to the power users, the devs, and the builders, and perhaps more importantly, I will be there. The location is Salt Lake City, the dates are October 9th to the 11th, and tickets are just $499. If you want to get 10% off, use code breakdown 10. Go to the Blockworks website, blockworks.com. There will be links to register for the conference, and again, you can use code breakdown 10 to get 10% off. Another interesting lens on the inflation picture is how it differs across America. For residents in

coastal cities and across the Midwest, housing pressures are still running hot and inflation is still way above target. Across the sunbelt, inflation pressures have eased much more rapidly and are now running below 2%. Phoenix and surrounding areas are now seeing 2.3% while Atlanta and Houston are both experiencing inflation at 1.7%. On average, the South now has inflation at 2.3%. Again, the major driving factor is housing costs. Major Southern metros were some of the hottest housing markets over the past few years. This drove inflation much faster in these regions, with Atlanta and Phoenix consistently seeing the highest rate of inflation for most of 22 and 23. The inverse is now happening with housing in southern cities stabilizing or even beginning to fall, taking a big chunk out of inflation

pressures. Bloomberg put an election slant on this data, noting that many of the battleground states are benefiting from rapidly cooling inflation. Traditionally, blue states that are in play this year, such as Michigan and Pennsylvania, are still seeing crushing inflation above 3%. But for the southern battlegrounds of Arizona and Georgia, inflation is running below the national average, which could theoretically provide a boost to the Democrats' economic credentials. Another angle, though, would be that this bifurcated economy makes the Fed's job that much harder. Ultimately, the U.S. is not a single economy, but rather a ton of regional economics stitched together. Prior to Wednesday's inflation print, J.P. Morgan, CEO Jamie Diamond, warned the Fed

not to declare victory too soon. He said, I would say the worst outcome is stagflation, recession and higher inflation. And by the way, I wouldn't take it off the table. Stagflation was the number one concern late last year as the labor market showed the first signs of weakness. While the rise in unemployment has been noteworthy, its progression has been slow and stagflation fears have disappeared from the headlines. Diamond noted that the government continues to run higher deficits and has a lot of infrastructure spending still in the pipeline, adding, they're all inflationary basically in the short run the next couple of years, so it's hard to look at it and say we're out of the woods. I don't think so.

Diamond is firmly in the recession camp, putting the odds of a soft landing between 35 and 40%. So while most commentators have written off any chance of a 50 basis point cut next week, some are still fighting the narrative battle. Goldman Sachs CEO David Solomon said, there's a case to be made for 50 based on more softening in the labor market. I think the percentage chance is in the low 30s. This statement highlights one of the biggest decision points for the Fed. Since the last meeting, Fed officials have been clear that the balance of risks between unemployment and inflation are now more even.

With inflation holding steady then at a slightly elevated level, the case for a 50-bases point cut would need to be based on labor market weakness. A big downside move in inflation would have cleared the decks for the Fed to go hard and tackling rising unemployment, but as the data has come in, the story is much more ambiguous. With no further improvement on inflation, the Fed would need to discard fears that inflation could reignite in order to support the labor market. This would be a huge pivot and one that hasn't been foreshadowed by any Fed officials. Jeremy Swartz, the CIO of Wisdom Tree, had a similar take but brought additional data to the table. He wrote, a 50 basis point cut should remain on the table.

Updating CPI with real-time metrics on shelter shows inflation at half of official levels. Alt-headline CPI is 1.2%. Alt-core CPI is 1.6%. Forget claims aggressive Fed cut indicates panic. The Fed should not be complacent. Get to a neutral policy sub 4% quickly. Schwartz used data from Zillow and apartment list to calculate that alternative rate of shelter inflation. Another notable commentary comes from Blackstone CFO Michael Chee, who thinks that the inflation fight is done according to his internal metrics. The alternative asset management firm coalesates their own inflation data that replaces shelter costs with an alternative measurement. According to Che, inflation is already at 1.7%, comfortably below the Fed's target.

For this reason, he said that his firm is cautiously optimistic about a soft landing. Meanwhile, other economic measurements from the firm show labor market weakening. Che said his discussion with portfolio companies lead him to believe wage growth will moderate over the next year, further tamping down on inflation. He acknowledged that there was decelerating revenue growth across portfolio companies, but also that those businesses have shown resilient margins. More promising for their operations, Che is starting to see a comeback in private equity deals after a year's long drought.

He said, we're seeing signs of the return of animal spirits and the transatlantic action market. If these trends hold, I think that could in particular lead to a pretty robust 2025. Ultimately, there's a few things that come through really clearly from this set of data and commentary. We're at a turning point in the macro regime and even the people at the pinnacle of the financial industry have wildly divergent views on what comes next. Based solely on CPI and other backwards-looking data, it seems as though inflation has stabilized somewhere near the Fed's target and is now moving sideways. Taking a look at forward-looking data, there's a few signs that economic conditions are continuing to trend down, and the global economy could be heading

into deflation. It's not enough to hang your hat on at this stage, but it's certainly enough to sit up and pay attention. While bank CEOs can't sound the alarm unless they're really sure, traders take risk based on these forward-looking indicators. At the height of inflation, traders were betting it would continue basically forever. We're now at a transition point where roughly 2% inflation is priced in over the long term. We haven't yet come to the point where positioning suggests a wave of deflation, but it wouldn't take much to tip the balance. This positioning speaks to how uncertain things are at the moment. Inflation is reasonable by any metric, but it's not accelerating to the downside.

The labor market is no longer red-hot, but we also haven't seen the spike of unemployment that signals a recession. The economy is at an equilibrium, but it's an uneasy one reached by rapid disinflation. There are a whole host of potential shocks rolling across the screen each day. Conditions in China have been bad for some time and seem to be getting worse. Multiple conflicts are still ongoing around the world and each poses a major threat along a multitude of angles. next Wednesday, the Fed will decide how to respond to this uncertain picture. In two months' time,

voters will decide the election and the Fed will hit another decision point. It's hard to look at everything going on and not feel as though they might have their work cut out for them. For now, though, that is going to do it for today's breakdown. Until next time, be safe and take care of each other. Peace.