The Breakdown - What the Highest Inflation in 4 Decades Means for Markets

Starting point is 00:00:00 This is what the popular discourse is becoming. These are no longer fringe conversations. These are no longer boring conversations. They're important conversations. And so every time you see a terrible take on inflation or any other macro issue, whether it's from a traditional finance person or a crypto person, just take a moment to remember how awesome it is that that's the discussion that we're having at all. 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 nexo. Abra and FTX and produced and distributed by CoinDesk. What's going on, guys? It is Wednesday,

Starting point is 00:00:43 January 12th, and today we are talking about what the highest inflation print in four, count them, four decades means for markets. First, though, if you are enjoying the breakdown, subscribe to the show, give the show a five-star rating, leave a review, or if you want to get deeper in the conversation, join the Breakers Discord. It's at bit.ly slash breakdown pod, and that link is also in the show notes. Now, today is CPI Day as in it's the day that we found out how inflation fared for December. This is, of course, the big macro conversation and has been for a year. In 2021, the battle was between, on the one hand, the Federal Reserve saying they were going to keep dovish monetary policy conditions because they believed inflation to be transitory,

Starting point is 00:01:36 i.e. just the product of supply chain dislocations and supply demand mismatch, coming after the worst of the shutdowns of the COVID crisis. And on the other side, markets who are saying you simply will not be able to handle inflation running as hot as it's likely to run. The Fed did its best to keep the transitory language going, but ultimately there was, in fact, a hawkish shift, and that happened between, call it September and December. The Fed started to acknowledge that while they still believed the same underlying conditions were causing inflation as they always had, it was less clear to them than ever how long it was going to take for supply chain issues to unwind and inflation to go down, and in the meantime, they weren't willing

Starting point is 00:02:18 to just let it run up any longer. We went from at the end of the summer not expecting any rate hikes in 2022 to by December an acknowledgement that we were likely to see three quarter point rate hikes in 2022. In addition to that, there would be an acceleration of the tapering of asset purchases to be concluded in early 2022. Now, markets found all of this fine. In fact, they improved after the December FOMC meeting. For one, it seemed like the Fed was actually addressing inflation in some way, or at least probably more importantly, acknowledging it. And second, it was very clear that Powell was not setting out to become some Paul Volker 2.0, willing to raise interest rates into the double digits and cause a recession in order to fight inflation.

Starting point is 00:03:03 That led to a general market rally going into the end of the year. But last week, that all changed when FOMC meeting minutes from December came out, and markets learned that the Fed had been briefed on not only asset purchase tapers, but in fact, quantitative, tightening, or the term that they used, balance sheet normalization. If quantitative easing involves buying assets to provide liquidity markets, quantitative tightening involves the opposite, selling assets into the open markets, and in turn, reducing liquidity. Now, that early and more aggressive QT that some had proposed in those minutes made many worry that we were heading into a secular shift to less liquidity and much faster than anyone anticipated. For the last week,

Starting point is 00:03:45 the market has been settling into this idea, and that's why you've seen really. risk assets, at least what traditional finance considers risk assets, like crypto, sell off. Still, there are going to be a lot of different points along this journey in 2022 where the stakes could change and where the outcomes could change. One of those is seeing monthly inflation prints that don't meet expectations to the downside. In other words, inflation that comes in lower than people expected. Should we see a set of months in a row where inflation seems to be declining, that would reduce the pressure on the Fed to make a sharp, hawkish turn. So, throughout 2022, we're going to be watching these things closely.

Starting point is 00:04:23 As Alex Kruger tweeted earlier this morning, thanks to Crypto, today's will be the most popular inflation report in history, crypto, making the boring fun since 2009. So let's get into what expectations were heading into today's numbers, and let's actually start with Jerome Powell's confirmation hearing for his second term as chair of the Federal Reserve. A few things stood out to me about this hearing. First, for those who just wanted to hear Powell talk about crypto, there are a very important. really wasn't much here. Senator Toomey got Jerome Powell to agree that the Fed shouldn't be probably a nationwide retail bank and that private stable coins can coexist with any sort of formal

Starting point is 00:05:02 U.S. digital dollar or Fed coin. When other questions of crypto as a threat to financial stability came up, Powell brushed them over pretty aggressively. It's very clear that crypto as a stability risk is not a big concern for him. Second, he spent a lot of time reminding people of what his and the Fed's mandate really was. There was a ton of discussion about the limitations of monetary policy. The Fed can't control supply, only demand. The Fed can't do much about structurally low participation due to poor child care and health care provisioning. The Fed can't change structural racism in the distribution of unemployment and wealth. The Fed can't build solar and wind farms. The Fed can't break up monopoly pricing power. In many ways,

Starting point is 00:05:45 it felt like Powell was gracefully trying to remind the Senate and Congress that it was their job to deal with these issues. And frankly, that was mirrored in his crypto talk. Unlike some of his counterparts in other central banks, he is really not pushing CBDCs. He's not trying to expand the role of the Fed, at least it seems like. He's got his mandates, which are financial stability and full employment, and he wants to stick to them. This is good because there was also a lot of political setup. With the midterm elections happening this year, there is going to be politics swirling all around these issues, and a lot of Republicans took the chance to remind Powell of the sacred importance of the Fed's independence from other political actors.

Starting point is 00:06:27 You have to imagine that as Biden and Democrats see shrinking approval numbers, there's going to be pretty intense pressure on the independence of the Fed. And by the way, that would be the case whichever party was in power. Nexto is a trusted and easy-to-use crypto platform where you can buy cryptocurrencies at the touch of a button and start earning up to 17% annual interest that is paid out daily. They support all of the major assets on the market and even allow you to swap one asset for another or borrow cash against your crypto without selling it. Nearly 3 million people in over 200 countries trust Nexo with their digital assets.

Starting point is 00:07:04 So whether you're just getting started or you're a season pro, get the most of your crypto today with Nexo at nexo.io. Today's episode is sponsored by Abra. Join over 1 million users and conquer crypto with Abra, an all-in-one, simple and secure app where you can trade over 110 cryptocurrencies. Get 0% interest loans using your crypto as collateral and earn interest with up to 14% APY on stablecoins and 8.15% APY on Bitcoin. Visit Abra.com or download the app from the Google Play or Apple App Store today.

Starting point is 00:07:44 Abra, Conquer Crypto. The breakdown is sponsored by FTX. FtX is the safe, regulated way to buy and sell Bitcoin and other digital assets. Trade crypto with up to 85% lower fees than top competitors. FtXUS is also the only leading exchange that supports both Ethereum and Solana NFTs. You can trade NFTs with no gas on FTXUS, and gas is subsidized when you withdraw off the platform. Help support the breakdown and visit FtX.us today. That's FTX.us.

Starting point is 00:08:24 Now, one more interesting piece to note from the conversation is that there was a bit more discussion on the national debt. John Kennedy from Louisiana said, how much is too much? At one point in your judgment, are we going to hit the point where you have to say, no, that's it, we can't do anymore. It's hurting the world. It's hurting our country. Powell responds, we don't know when that is, as the world's reserve currency demand for our paper is very strong. If you had shown that chart of federal debt and then asked somebody 15 years ago to predict what interest rates would be, they wouldn't be predicting that the tenure would be at 1.75 percent. There's been a lot of demand.

Starting point is 00:08:55 They would have looked at that picture and said, you must be experiencing difficulty borrowing, but we're not at all. We're on an unsustainable path. Debt is not at an unsustainable level, but the path is unsustainable, meaningfully faster than the economy. Meaningfully faster than the economy. We have to address that over time. We will address that over time. And the better way to do it is soon and do it in good times. Start when the economy is strong and the taxes are rolling in. We don't do fiscal policy, but I will say sustainability of the debt. is something we need to get back to and focus on again. As you see again, Powell there focusing on what is and isn't within his mandate. Luke Gromond for his part is not buying it, saying

Starting point is 00:09:29 the fact that the Fed has a $9 trillion balance sheet versus $29 trillion in federal debt is proof the U.S. government has been having difficulty borrowing. I haven't seen policymaker obfuscation like Powell since I watched HBO's Chernobyl. No wonder central banks keep buying gold. Still, the biggest point relative to where markets have been for the last week was the softening of the stance and the minutes on discussions around balance sheet reduction. Powell basically said these were preliminary only, that no decisions had been made yet, that discussions will be going on over the next few meetings, and that ultimately everything was going to be data.

Starting point is 00:10:01 Powell basically said that they want to be positioned to be able to reduce the balance sheet if they need to, not that they will or that they must. Given that markets have been rallying, at least to some degree, since the hearings, many think this is the exact reason why. Investing.com summed up, Fed Chair Powell, we probably remain in an era of very low interest rates. Powell, we haven't made any decision regarding balance sheet reduction, and then added the money printer go Burmeme. But now let's get back to Twitter and their expectations for inflation before it actually happened today. Lin Alden set up

Starting point is 00:10:31 the overall situation. December CPI comes out tomorrow and has a decent shot at reaching 7% plus year over year. But then unless monthly inflation accelerates from here, the year-over-year figure will likely peak within Q1-20202. House prices and apartment rents have topped in many markets for now. However, The components of CPI that measure those are on a multi-month lag, and so they haven't topped yet. Used car prices likely haven't topped yet either, according to industry estimates. When they do top, as semiconductors get released freeing up manufacturer inventory, this will be a disinflationary impulse, just not yet. Energy remains a key area of concern for sticky inflation over the longer term, and that runs downstream into everything else, food, materials, transportation,

Starting point is 00:11:09 manufacturing, etc. The world remains rather tight on energy due to low investment. Adolfo and Twitter gave the expectations calibrated setup, saying, Bulls, tech, bonds, and growth will want a CPI print of 7.4% and lower. Bears, tech and bonds, but bullish oil and financial, will want a CPI print of 7.5% and higher. Alex Kruger brought it to crypto and said, gun to my head, tomorrow's inflation comes in line and the crypto reversal continues. Bitcoin sellers re-engage around 46K,

Starting point is 00:11:39 Alts enjoy further upside. Too much inflation talk. even my barber mentioned it. Only a large CPI upside surprise would see prices crash. Light Crypto echoes this saying Powell has been a steadfast soothsayer in his remarks as far as I can remember, yet you lot panicked into it. Crypto Twitter jumping on the macro bandwagon has been the one sentiment indicator that still works. Anything other than a jaw-dropping CPI tomorrow means up. CMS Holding put it this way, he said, CPI better be 25% tomorrow for how whiny you all have been. So what actually happened?

Starting point is 00:12:11 Well, CPI was not 25%, but U.S. inflation did hit a 39-year high, the highest number since June 1982, 7% year-over-year and 0.5% from November. Shelter and used vehicles led the pack with fuel actually falling. Now, core CPI, which excludes food and energy, accelerated by slightly larger than forecast 0.6% last month, 5.5% from a year ago, which is the biggest jump since 1991. That means that overall the number was right in line with expectations, while core CPI was just a little bit higher. So how did the market react? Well, as I kind of mentioned, this is exactly what everyone expected. And frankly, meeting expectations is in market terms bullish. From Bloomberg, market expectations for Fed tightening expected in March and 22 as a whole were

Starting point is 00:12:57 largely unchanged after the report. Joe Wisenthal from Bloomberg reinforces this saying, while the core rate was, in fact, hotter than expected, seems like markets taking the glass half full view of this report. Now, this doesn't mean inflation isn't still a serious problem for regular people. Sarah House from Wells Fargo says there is still tremendous momentum when it comes to inflation right now. While inflation is likely to peak in the next few months, the overall pace is going to remain a challenge for consumers, businesses and policy. Perhaps the hardest part is that inflation continues to increase faster than wages. Businesses are increasing pay, but inflation is eating at all. Inflation adjusted average hourly earnings dropped 2.4% year over year in December.

Starting point is 00:13:36 What about from a Bitcoin perspective? Well, the folks that said anything other than a massive overshoot of the CPI expectations was bullish? Kind of right. Bitcoin was up 1.1% to 43,900 in the minutes after the report came out and is up about 3% overall since the hearing yesterday. So two things to close out on. One has to do with what happens next in markets. And I'm going to quote Mike Epilito from Blockworks who wrote, it looks like there's a consensus forming. One, the Fed will try to tighten in Q1. Two, assets will crash and the Fed will get spooked. Three, the Fed will loosen sending assets to fresh all-time highs. This is your reminder that the market never does what everyone expects it to do. I think Mike's caution is well

Starting point is 00:14:15 warranted and something to keep in mind. But where I actually want to close is on Alex Kruger's point about crypto making the boring interesting. There are a lot of absolutely dog shit takes on inflation out there, including, frankly, a lot of them from folks that we all listening to this show mostly agree with on many other things. But the fact that a big and growing part of the population is engaging with questions around inflation and monetary policy is insanely bullish for the future of the country as a whole. I'll leave you with this mini thread from this week from Saquan Barkley, the New York Giants Running Back, who wrote,

Starting point is 00:14:53 I want my career earnings to last generations. The average NFL career is three years and inflation is real. Saving and preserving money over time is hard no matter who you are. In today's world, how do we save? This is why I believe in Bitcoin. Almost all professional athletes make the majority of their career earnings in their 20s. With a lack of education, inaccessible tools, and inflation, a sad yet common reality as many enter bankruptcy later on.

Starting point is 00:15:16 We can do better. We need to improve financial literacy. Bitcoin is a proven, safe, global, and open system that allows anyone to save money. It's the most accessible asset we've ever seen. Anyone reading this has access to Bitcoin. That is not true for real estate and other assets. This is why my endorsements pay me in Bitcoin. Throughout my life, I believe Bitcoin will continue to appreciate over the long term,

Starting point is 00:15:37 allowing me to save and preserve the wealth I'm creating today as a professional athlete. He then goes on to share his download link for Strike and talks about how he's donating his efforts to Covenant House, all of which is really cool. But the thing that I want to point out is just that this is what the popular discourse is becoming. These are no longer fringe conversations. These are no longer boring conversations. They're important conversations. And so every time you see a terrible take on inflation or any other macro issue, whether it's from a traditional finance person or a crypto person, just take a moment to remember how awesome it is that that's the discussion that we're having at all. I want to say thanks again to my sponsors, nexo.io, Abra, and FTX, and

Starting point is 00:16:17 thanks to all you guys for listening. Until tomorrow, be safe and take care of each other. Peace.

The Breakdown - What the Highest Inflation in 4 Decades Means for Markets

There aren't comments yet for this episode. Click on any sentence in the transcript to leave a comment.