The Breakdown - With Latest CPI, the Fed Hiking Cycle Finally Appears Over

Episode Date: November 15, 2023

Before today's CPI numbers were released, markets were pricing in a 14% chance of one more rate hike. After the numbers were released, that number plummeted to zero. NLW catches up on the macro. Today's Sponsor: Kraken Kraken: See what crypto can be - https://kraken.com/TheBreakdown 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 Tuesday, November 14th, and today we are talking CPI and macro. 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 of the show notes or go to bit.ly slash breakdown pod. Well, friends, like I said, today we are shifting our coverage from just never-ending bullish shifts and sentiment to a macro conversation. It has been a while, and I want to use the occasion of the

CPI results to check in on how things are going from a larger perspective. Now, one interesting thing to note around this month's CPI is, frankly, the lack of coverage. There are very few articles in the lead-up compared to when inflation was still high and volatile. Even over the last few months, it was easy to work up by, does this CPI print mean the Fed is done type of article? But this time around, there just wasn't a lot of interesting speculation to be had ahead of the print. One might take this as a good sign, foreshadowing a return to the world where CPI prints in Fed meetings aren't the most notable economic event of the entire calendar month. So, among those who were paying attention, though, what were the predictions?

Analysts had by and large thought that this morning CPI print would show the continued steady decline of inflation. Headline inflation for October was forecast to cool to 3,000, 3.3% annualized, with a monthly increase of just 0.1%. September CPI showed a 0.4% monthly increase and the 3.7% annualized rate of inflation, so these predictions would mark another significant decline if they were to come true. Now, after bottoming at 3% in June, headline CPI is ticked up over the past three months, so seeing this trend breakdown could help calm fears that another inflationary pulse is on the horizon. Core inflation, which excludes food and energy, was forecast to remain stuck at 4.1% on an annualized basis. The month's

monthly increase was predicted to remain at an elevated 0.35%, which would be in line with annualized core inflation above 4%. Now, the Fed prefers to use core PCE data rather than core CPI as their key inflation benchmark. Even so, both metrics continue to run well above the Fed's 2% target and appear to have stalled out. Given that, officials will likely leave open the possibility of future rate hikes as long as core CPI is running at the current monthly pace. Bloomberg Economist said, after showing encouraging progress this summer, disinflation in years, year-over-year core CPI likely stalled, while the monthly pace has been creeping up towards something more consistent with an annualized inflation pace of 3 to 4% than 2%.

Now, of course, the big question from this inflation print is whether the Fed has done enough to bring core inflation down and can continue to justify its pause. The Fed has declined to hike interest rates at three of the past four FOMC meetings. Overnight, markets were pricing the chances of a Fed rate hike at the December meeting at just 14.3%, and more broadly betting that the hiking cycle is already over. The only thing that could really knock that prediction off course would be an unexpected rise in inflation. So October CPI was being viewed as the piece of data which could confirm that the Fed is done hiking rates. So what did we get? The Wall Street Journal article reads,

cooling inflation likely ends Fed rate hikes. Overall, inflation was flat and up 3.2% from a year earlier, which was, of course, lower than September. And just as relevantly lower than anticipated. Core inflation came in at a 2.8% annual rate, which was much lower than anticipated. and was down from 5.1% during the first five months of the year. Stocks absolutely took off on the release of the news, with investors concluding that the Fed was officially well and fully done raising rates. Harvard economist Jason Furman wrote,

odds of a Fed rate hike at the December meeting went from 14% to 0% after the CPI report. Now, you've started to see Fed officials actually begin to make the soft landing call. Chicago Fed President Ostend Gulsby said in an interview last week, we may have brought down inflation as fast as it has ever come down, and we did that without starting a recession. Now, given this almost immediately, speculation turned entirely to when the Fed actually starts to cut rates. At the time of recording the lead headline on Bloomberg, for example, is Citadel's Ken Griffin says Fed's credibility at risk if it cuts rates too soon. Kathy Wood, meanwhile, says that U.S. inflation will turn negative in 2024, arguing that deflation is already underway. On Bloomberg

TV this morning, she said, the Federal Reserve has overdone it. We're going to see a lot more deflation going forward. If we're right and they've gone way too far, they'll have to cut fairly significantly. Now, trying to tamp down some of this, Richmond Fed President Thomas Barkin said, quote, I'm just not convinced that inflation is on some smooth glide path down to 2%. The inflation numbers have come down, but much of that drop has been partial reversal of COVID-era price spikes, which were driven by elevated demand and supply shortages. Shelter and shelter inflation remain higher than historic levels, so does services inflation.

Now, of course, another key data point that the Fed watches closely is consumer inflation expectations. On Monday, the Federal Reserve Bank of New York released their October report on consumer expectations, which showed that survey participants expected to see inflation falling to 3.6% on a one-year time horizon and a 2.7% across five years. Both of these measures were slightly down on the previous month's result, with the three-year time horizon remaining the same at 3%. Additionally, a smaller share of respondents reported difficulties accessing credit compared to a year ago, But the perceived odds of losing a job over the next year ticked up slightly to 12.7%, although the probability of finding a new job also improved slightly. At the same time, the survey contains

some grim expectations for increases in essential expenses. Year-ahead rent costs remain highly elevated at a 9.1% increase, while food costs were expected to move up by 5.6%. Expected inflation and gas prices ticked up slightly to 5%, with college education increasing to 6% and medical care to 9.1%. Year-ahead earnings growth expectations. expectations decreased slightly to 2.8%. The University of Michigan Consumer Sentiment Index, which was updated on Friday, showed long-term inflation expectations hitting a 12-year high. According to their surveys, consumers expect inflation to run at 3.2% over the long term, which is a level not seen since 2011. Simultaneously, consumer sentiment hit a six-month low.

Inflation expectations over the next year moved up from the previous month's level to 4.4%. Nearly 1 in 5 survey respondents said that unemployment would cause more hardship than inflation over the coming year. Joanne Sue, the director of the survey, said in a statement, the combination of expectations for persistently high prices, high borrowing costs, and labor market weakness does not bode well for the prospect of continued strength in consumer spending and economic growth. Now, I think that these survey results tell a lot of the story of the U.S. economy, at least from a perception standpoint. Consumers have, by and large, given up on wage increases keeping up with inflation, even as it moderates. They expect

inflation and basic necessities to continue running at highly elevated levels, which stresses household balance sheets. On top of that, long-term inflationary expectations are hitting decade-long highs only seen during times of acute stress. Economic analyst Amy Nixon said, At what should be the tail end of a fairly aggressive tightening cycle, it's not particularly encouraging to see inflation expectations rapidly sailing upwards towards the peak they were at when the Fed had barely begun tightening yet. Today's episode is brought to you by Cracken. For far too long, the whole financial system has been standing still. Too slow. only on for certain hours. Overly designed for some types of people, but not for others. Crypto, at

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Now, sticking on the not-so-good news theme for just a moment, on Friday after markets close, ratings agency Moody's delivered something of a shock. Moody's lowered their outlook on U.S. government debt from stable to negative. A preliminary warning before a formal downgrade. Moody's is the only remaining ratings agency with U.S. debt listed as AAA after Fitch downgraded the U.S. government to a AA-plus credit rating in August. Moody's explained their decision on the basis of large fiscal deficits, a decline in debt affordability, and continued political polarization in Congress. Christopher Hodge, chief economist for the U.S. at Nataxis, said, it's hard to disagree with the rationale, with no reasonable expectation for fiscal consolidation anytime soon.

deficits will remain large, and as interest costs take up a larger share of the budget, the debt burden will continue to grow. Treasury Secretary Janet Yellen said Moody's call was a, quote, decision that I disagree with, adding, the American economy is fundamentally strong, and Treasury securities remain the world's preeminent safe and liquid asset. Charles Payne from Fox Business wrote, Moody's is pissed. This isn't news to Wall Street, but should be a clarion call to Main Street. Even the greatest country in the world has limits to feckless spending. Time to hit the brakes. On the flip side, Keith Wiener from Monetary Meadows said, Ratings Agency cut rating of U.S. government debt. So what? It's still the same irredeemable currency system

to hold a money balance you still have to buy directly or indirectly treasury bonds. The rest of the world must still get dollars to service their dollar debts. If a corporation is downgraded, there can be a sell-off. That's not the case with the U.S. Treasury. Jim Bianco pointed out why downgrades have less of an effect than they might once have had. He wrote, When S&B downgraded the U.S. in August 2011, it was a shock and concern, as many financial contracts were written that collateral had to be AAA rated. Since the U.S. was

split-rated and still majority AAA, as Fitch and Moody still had the U.S. AAA, it was considered a AAA country and dodged the bullet. In the subsequent 12 years, most of these financial contracts have been rewritten to include AAA or debt backed by the U.S. government or words to this effect. So when Fitch downgraded the U.S. on August 1st, and the U.S. became a split-rated double-A-plus country, it did not lead to a forced unwind of repos, loans, derivatives like margin at futures exchanges and investment contracts. Now that Moody's might downgrade the U.S. to AA plus, it does not change its current rating. Effectively nothing changes. Now, going back to that idea of political dysfunction, stories abound once again about the U.S. government being on the brink of another

government shutdown. Current estimates have the Treasury running out of cash by Friday, forcing Congress to focus debate on how to fund the government. During the last government shutdown standoff, the compromise was to pass a 45-day funding bill in order to buy Congress additional time to hash out a more permanent solution. Since then, Freedom Caucus Republicans have removed House Speaker Kevin McCarthy and replaced him with little-known Representative Mike Johnson. A key pillar in the long list of Freedom Caucus complaints centered on reforming the way the government funding currently works. Since 1990, the government has allocated spending using massive and incomprehensible omnibus bills rather than passing itemized budgets. In the early years, these omnibus bills helped reduce the

budget deficit. More recently, however, they have been viewed as a major contributor to reckless and unnecessary spending. Because the bills are so large, it has become impossible to properly scrutinize and debate spending measures. So, Freedom Caucus Republicans insist on a return to individual budgets in order to rein in government deficits. So far, negotiations with the Freedom Caucus seem to be going poorly. How Speaker Johnson put forward a compromised position on Saturday. The proposal sets out a two-step approach to funding the government. One bill would extend funding for military construction, veterans affairs, transportation, housing, and the energy department until January 19th, the second bill extends funding to the rest of the government until February 2nd.

The bills do not include the deep spending cuts demanded by the most right-wing Republicans, nor do they bring to fruition the reform of individual budgeting. Instead, they are merely another set of stopgap measures to allow the debates over these topics to be deferred to another day. Now, this blissfully not being a politics show, I won't go into the reactions and counter-reactions and everything going into. Suffice it to say, particularly if you're looking for things like, oh, I don't know, crypto legislation to be discussed, it's not happening until these things get sorted out. Really in many ways as we wrap up, you can sense a shift where we finally seem to have gotten confirmation today, at least in the minds of many Wall Street analysts, that the hiking cycle is

well and truly over. Perhaps not surprisingly then, Wall Street banks have begun publishing their rate forecast for next year. Analysts agree that the Fed will begin cutting rates, but there's some major differences on how fast and how deep the cuts will be. Morgan Stanley has rate cuts starting in June with a 25 basis point reduction and then repeated in September, and they have the pace increasing into the final quarter with a rate cut at every meeting, bringing the policy rate rate to two point 375% by the end of 2025. Goldman Sachs thinks the Fed will hold off a little longer, keeping rates steady until the fourth quarter. They're also forecasting much slower pace for rate cuts, predicting one cut per quarter through mid-20206. Their analysts think rates will settle around

3.5 to 3.75% rather than dipping lower. Now, part of the difference is that Morgan Stanley's team is forecasting a much weaker economy than their rivals, although they do not have a recession as their baseline assumption. They have a slightly higher peak for unemployment in 2025 compared to Fed forecasts, expecting that the figure will top out at 4.3%. They're also projecting weaker growth and inflation than the economists at the central bank. Still, UBS is putting forward the most pessimistic forecast so far, expecting deep cuts in 2024 to bring the policy rate down to as low as 2.5% by the end of next year. They think this rate slide will continue into 2025, reaching a floor of 1.25%. Now, part of that is that UBS is working with the assumption of a U.S. recession during that time

period, which would force deeper rate cuts. They also think trouble will begin earlier than most with the first rate cut forecast in March. Now, given all that, I think it would be a reasonable take to say, basically nobody knows, but you can at least see where their heads are at focusing on what happens next year and the rate cuts to come, rather than on speculation around whether we have any more rate hikes to go. That's the story from here. Until next time, be safe and take care of each other. Peace.