The Breakdown - Will the Fed Shift Policy Due to Increasing Inflation?

Starting point is 00:00:00 They believe it to be simply transitory inflation or base effect-driven inflation. If everyone thought as they do, they would have no issue. But people don't think as they do. People are observing prices go up, and enough of these prices going up that there is fodder for this inflation narrative. The thing is, inflation is a self-fulfilling prophecy. When people believe that inflation is going to increase the price of goods next month, they buy what they can now.

Starting point is 00:00:25 That new demand creates the pressure that actually pushes the price to go up. And bingo-bango, transitory base effect inflation becomes real inflation. 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 nexor.io and bitstamp, and produced and distributed by CoinDest. What's going on, guys? It is Wednesday, June 16th, and today's episode is all about rumblings of a shift in macro policy, specifically about what we might hear at this afternoon's Federal Open Market Committee briefing and what people think it might mean. So let's briefly set the

Starting point is 00:01:11 stage. You have to go back to 1971, and no, I'm just kidding, at least for this episode. But in point of fact, let's go back to the great financial crisis. In the wake of that turmoil, the Fed sets up a raft of new facilities to better support the market. And by support, we know we really mean not let markets fail. This includes reducing interest rates, quantitative easing, i.e. purchasing bonds and other assets to get money into the system, etc. The next few years are rocky. On the one hand, there is a sense from some corners that the Fed hasn't done enough, that recovery was too sluggish. Some of the lasting real effects of that are with us today. The housing shortage is at least partially due to builders not being willing to ramp back up to their previous full capacity. Today,

Starting point is 00:01:56 the National Association of Realtors released a report saying that we are 5.5 million units short of needed levels. We've only been building about 1.125 million units per year. There are others who say that the Fed's continuation of wartime financial policies until years after are absolutely insane. Getting markets addicted to cheap money, creating massive dislocations along the way. If you're in the Bitcoin space, you are living inside one of the responses to exactly that. But unwinding support is difficult. In 2013, the Fed announced a future tapering of QE policies. Keep in mind, this wasn't a specific date or deadline or any details of how that tapering was going to happen. The Fed had at that point increased the size of the balance sheet from $1 trillion to $3 trillion. Seems quaint now

Starting point is 00:02:44 with our $8 trillion balance sheet, but that's neither here or there. The point was that they had just suggested that at some point in the future they would have to ease off, and the market had a collective freak out that drove a massive spike in U.S. Treasury yields. This became known as the taper tantrum and was one of the key historical moments in showing just how addicted to Fed's support and Fed liquidity markets had become. All in all, whatever one thinks of the correctness or incorrectness of the Fed's actions, there is obvious truth in the notion that we are living in what Travis Kling has called the largest monetary policy experiment in history. Okay, now fast forward to last year's COVID shutdowns. The great financial crisis-era Fed facilities are dusted off. The engines are

Starting point is 00:03:30 restarted with vigor. Only this time, it's not just the Fed. It's central banks around the world as well. Markets initially hemorrhage on the news of shutdowns. What will it mean for the real economy, for jobs, for business, for everything? How long will it last? As such, the S&P 500 crashed. This you would expect, right? It's a global pandemic that is shutting down business everywhere for God's sake. then a weird thing happened. Markets started to bounce back rather quickly. And it wasn't hedge funds or institutional investors leading the charge. It was a bunch of day trading barbarians. Was there confidence the product of a renewed belief in the resilience of the American spirit, the inevitable triumph of the American business engine? No, not really. It's that over the last decade,

Starting point is 00:04:20 they learned that there's absolutely no way the powers that be were going to let markets fall for long. I'll never forget watching Barstool founder Dave Portnoy when he started day trading and live-streaming it because there was nothing else to do. There were no sports. At the beginning, he went short on a bunch of things that he figured would be hampered by, you know, the complete shutdown of the economy, airlines, etc., and so on. He got absolutely demolished. I mean, he was just destroyed. And that's when he realized, stocks only go up. There are some great clips of him real time coming to the notion that the suits in Washington would never let the prices of stocks go down and all he had to do to make money was to recognize that singular fact. Yes, the recovery of the stock market was not based on any sense of

Starting point is 00:05:09 fundamentals, but by the unerring belief in the truth behind the meme, money printer go burr. And let me tell you, the assault of retail made more than a few hedge funders look stupid. I mean big, storied investors who absolutely ate their shirts betting against the markets, or more specifically, betting against the Fed, or more specifically, specifically, betting against the assumption and meaming of people had regarding the Fed. When those institutional investors and hedge funders switched back to bullish, the rally that followed absolutely ripped. Valuations got to historic levels, particularly for tech stocks and things farther out on the risk curve. This was the backdrop against which Bitcoin's rally started

Starting point is 00:05:54 as well. A new moment of monetary policy-driven macro-bull markets for risk on assets, and a supporting institutional narrative that when everything went to hell, as it eventually must, Bitcoin and its programmatically fixed supply would be there for us all. The point of all of this is to make clear how much of the context for the performance of crypto markets, in fact all markets, over the last year has been in larger monetary policy. Looking for the best way to unlock your crypto's liquidity, nexo.io is exactly what you need. Borrow against your digital assets at just 6.9% APR,

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Starting point is 00:07:22 Visit bitstamp.net to learn more. BitStamp for all the ways we crypto. Now we're in 2021. The vaccine has come to be. Reopening's are in full swing. There is renewed energy, renewed activity, renewed spending. And there is also inflation. CPI hit 5% in the latest monthly numbers, and there is a great debate going on around how to interpret that. One camp, which includes the Fed, says that inflation is two things. First, it's the byproduct of so-called base effects. Inflation is measured year over year. Given that, we need to take into account how much was shutting down last year at this time. No one was buying anything or doing anything. That's going to show up as a distortion in the number. It's going to make

Starting point is 00:08:12 current prices and activity, i.e. inflation, a year later, look more extreme. The other things that this camp, including the Fed, says that inflation is, is transitory. In other words, there's a recalibration going on in markets as they come back online in short order. But ultimately, that recalibration should level out, prices should return to normal, and everything will be hunky-dory. On Real Vision yesterday, former breakdown guest Tony Greer put the two camps of discussion around inflation this way. He said that the two camps forming are first, the transitory inflation camp, including the Fed, and the second, the transitory My Ass camp featuring investors like Paul Tudor Jones, Jamie Diamond, and well, a huge number of market participants. But from a market perspective,

Starting point is 00:08:55 what is the concern with inflation really? Well, in short, if there is inflation, the assumption is that the Fed will have to unwind its policies. That means letting interest rates rise. That means stopping the $120 billion monthly bond purchase program. You might be saying to yourself, wouldn't this just be the economy going back to normal? Well, yes, that's one view. But remember what we discussed before. Stock prices, risk on asset prices have been driven up by the influx of cheap money. There is an expectation that if policies turn hawkish, it will have a huge negative impact on the price of stocks. This could also have a big impact on crypto as well. On May 20th, Chow Wang tweeted,

Starting point is 00:09:33 I'm seeing a growing tapering narrative in the macro world. This is by far the most important thing you should pay attention to as far as the bull market is concerned. More important than any chart, metrics, or narratives you are looking at. Virtually every coin company and product in crypto is at least indirectly fueled by central bank-induced speculative fervor. So long as this is the case, we are highly very very very much. vulnerable to central bankers' decisions. It has been about two months now since the larger macro environment started to really think that there is an inevitable unwind coming, that inflation

Starting point is 00:10:02 will force Jerome Powell's hand. If you need the sense of how this can impact prices, go look at arcs chart and Bitcoin's chart during that time period. So coming back to the Fed itself, why wouldn't they peel back the support in the face of inflation and just the economy getting better? The Fed has said over and over again that its goal is to get back to full unemployment, even if that means letting inflation run hot. Remember, they've adjusted how they view inflation from a policy decision-making standpoint. They want sustained inflation over time of over 2% before they change policy rather than just hitting 2% once. What's more, they want to actually observe the inflation, not just project it before they change policy. The big concern for the Fed, however, might not be

Starting point is 00:10:46 the inflation itself. Remember, they believe it to be simply transitory inflation or base-effect-driven inflation. In other words, if everyone thought as they do, they would have no issue. But people don't think as they do. People are observing prices go up, and enough of these prices going up, from lumber to use cars to sandwiches, that there is fodder for this inflation narrative. The thing is, inflation is a self-fulfilling prophecy. When people believe that inflation is going to increase the price of goods next month, they buy what they can now. That new demand creates the pressure that actually pushes the price to go up, and bingo-bango, transitory base effect inflation becomes real inflation. So if you're the Fed, and if you can't convince everyone that this

Starting point is 00:11:28 is transitory, you basically have to make policy on the belief that it isn't. At least, that's the increasing speculation. The Wall Street Journal's top headline reads, Fed meeting likely to signal possible policy shifts. Federal Reserve officials' new economic forecast could suggest interest rates rising sooner than previously expected. And it's exactly this conundrum that they're dealing with. So the thing that people expect specifically, first, they expect that the Fed will keep policies the same in the short term, rates near zero, up to $120 billion a month of treasury and mortgage bonds. But people also anticipate forecasts showing officials expecting to raise interest rates sooner than they anticipated when surveyed in

Starting point is 00:12:07 March, when most believe that the key Fed fund rate would remain steady through 2023. Many also anticipate discussion of how to start scaling back bond purchases. All in a all, the sentiment seems to be shifting that the Fed is getting some amount of confidence to begin unwinding. The last graph of the Wall Street Journal piece reads, quote, Fed officials indicated before the blackout period that they believe the labor market still needed central bank support, but they also realize that the U.S. economy, powered by trillions of dollars of fiscal stimulus, currently has too much momentum to be knocked off course by the temporary market turmoil that an earlier than expected Fed policy shift would spark. Put differently, they think they might

Starting point is 00:12:47 be able to get away with a little bit of tapering discussion without too much of a tantrum. What's for sure is that this has real market impacts on the decisions investors are making. In his appearance on CNBC on Monday, Paul Tudor Jones said, quote, the only thing I know for certain, I want 5% in gold, 5% in Bitcoin, 5% in cash, 5% in commodities. At this point in time, I don't know what I want to do with the other 80% until I see what the Fed is going to do. You can absolutely feel in this market just how in-between everyone feels things are. I've been talking about it for weeks and headlines even in crypto today reflect it.

Starting point is 00:13:24 On CoinDesk, you can read Bitcoin enters wait-and-see phase ahead of Fed meeting. These liminal in-between periods are inherently uncomfortable. So, strap in, sit back, and I'll be back tomorrow with an update after the briefing. Until tomorrow, guys, be safe and take care of each other. Peace.

The Breakdown - Will the Fed Shift Policy Due to Increasing Inflation?

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