More sense of the changes coming ahead of today’s FOMC briefing.
On today’s episode, NLW looks at the Federal Open Markets Committee briefing coming up this afternoon and discusses what it might signal in terms of future monetary policy. The discussion includes:
- How the Great Financial Crisis inspired “the largest monetary policy experiment in history”
- 2013’s “Taper Tantrum”
- The return to GFC era policies during COVID-19
- The insurgency of meme traders
- Why inflation is a self-fulfilling prophecy
Image credit: Drew Angerer/Getty Images News
What's going on guys? It is Wednesday, June 16, 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 stage. You have to go back to 1971, and, nah, 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, 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 1.1 to 5 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 one trillion to three trillion. It seems quaint now, with our $8 trillion balance sheet, but that's neither here nor there. The point was, they just suggested that at some point in the future, they would have to ease off and the market had a collective freakout 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 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 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. But 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 their confidence the product of a renewed belief in the resilience of the American spirit, the inevitable triumph of the American business engine? Nah, not really. It's that over the last decade, 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, realtime, 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 fundamentals, but by the unerring belief in the truth behind the meme, "Money Printer Go Brr."
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 market, or more specifically, betting against the Fed, or more specifically specifically, betting against the assumption and meaning 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 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. But now, we're in 2021, the vaccine has come to be, reopenings 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 was 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 current prices and activity, i.e. inflation, a year later look more extreme. The other thing 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 Dimon, and well, a huge number of market participants.
But, from a market perspective, 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 20, Qiao Wang tweeted, "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 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 will force Jerome Powell's hand. If you need a sense of how it's gonna impact prices, go look at arcs chart and bitcoins 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 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 used 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 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 forecasts 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 expected 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 March, when most believed 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 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, "Fed officials indicated before the blackout period that they believe the labor markets 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 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, "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 reflected it. 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!