Will the Fed Thread the Needle? with Itay Vinik

Itay Vinik is the Co-Founder & Chief Investment Officer at Equi, an alternative investment platform that brings investment strategies to accredited investors. Today, Itay returns to the pod to answer the question: can the Fed thread the needle between inflation and recession? ------ ✨ BECOME A BANKLESS CITIZEN ✨ https://www.bankless.com?utm_source=YouTube&utm_medium=ChannelLinks&utm_campaign=Website https://www.bankless.com?utm_source=YouTube&utm_medium=ChannelLinks&utm_campaign=Website! ------ BANKLESS SPONSOR TOOLS: ⚖️ ARBITRUM | SCALING ETHEREUM https://bankless.cc/Arbitrum 🐙KRAKEN | MOST-TRUSTED CRYPTO EXCHANGE https://bankless.cc/kraken 🦄UNISWAP | ON-CHAIN MARKETPLACE https://bankless.cc/uniswap 👻 PHANTOM | FRIENDLY MULTICHAIN WALLET https://bankless.cc/phantom-waitlist 🦊METAMASK LEARN | HELPFUL WEB3 RESOURCE https://bankless.cc/MetaMask ------ Topics Covered 0:00 Intro 6:00 Itay Returns 8:00 Reflecting on 2022 12:04 Equi Portfolio 15:35 Threading the Needle 19:10 Destroying Wealth 26:45 Accelerating Chaos 29:10 Inflation and Monetary Supply 38:30 The Fed is Bleeding 43:30 Small Cap Stocks 46:00 Will the Fed Pivot? 55:14 Economic Recession 1:01:14 Recession Indicators 1:02:59 Hopium 1:06:24 The US Banking System 1:09:44 How to Analyze the Economy ------ Resources: Itay Vinik https://twitter.com/VinikItay?s=20 Equi https://www.equi.com/ Links to our recent macro series https://youtu.be/pP_HHE0kFhA https://youtu.be/E8lxrsF29u0 https://youtu.be/-DzY_pCFGbI. https://youtube.com/live/eregdZPLYjg. https://youtu.be/5sNCrPAwt6w ----- Not financial or tax advice. This channel is strictly educational and is not investment advice or a solicitation to buy or sell any assets or to make any financial decisions. This video is not tax advice. Talk to your accountant. Do your own research. Disclosure. From time-to-time I may add links in this newsletter to products I use. I may receive commission if you make a purchase through one of these links. Additionally, the Bankless writers hold crypto assets. See our investment disclosures here: https://www.bankless.com/disclosures

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:04David Hoffman?

  Bankless Nation, welcome to the state of the nation where today we are asking the question, can the Fed thread the needle? Can the Fed thread the needle between inflation and a recession? We've been going on this world tour of macro. It started with the banking crisis, the biology, bit signal, followed by Arthur Hayes, Ben Hunt, and finally Jim Bianco. And so Bankless Nation, wow, this is a macro episode. The conversation here today is not a part of that macro world tour. Today, we are bringing back on Itay Vinik. We've had him on once before. He is coming equipped with a mass of graphics, slides, charts to walk us through an extremely

• 0:45David Hoffman?

  thorough audit of the US economy, the banking sector, the equities market, risk assets, and interest rates and inflation, all in the hopes of answering, can the Fed thread the needle between decreasing inflation while not triggering a recession? So, just a snapshot this, we have core inflation that is yet to turn over. That thing is still up and to the right. We have consumer health running on fumes, and we have a Federal Reserve that is still increasing interest rates in the face of a banking crisis. Itay thinks the next three months are critical to seeing what happens next in global markets everywhere, and he's going to walk us through all of the data to help us understand this picture. Bankless Nation, this is a very, very visual heavy podcast, so if you have the luxury

• 1:29David Hoffman?

  of watching this video on YouTube or on Spotify, this would be one of those episodes to do that. Although I do my best to articulate the charts and the vibe along the way for all the podcast listeners, it would be useful to be able to watch this visually. Ryan, the AI is powered down for today's show. It's just me, but Itay is a fantastic guest who's in the driver's seat for this show with all the slides. Last thing before we get into the show, are you a subscriber to Bankless? Are you a Bankless citizen? Why not? Because there are so many cool perks of being a Bankless citizen. In our Discord, the Bankless Nation Discord, I've got my own Q&A room if you want to come and chat with me and ask me questions directly. And if you want this podcast but without the ads, there is an ad Ad-free RSS feed for the ad-free listening experience.

• 2:13David Hoffman?

  It also comes with an extra podcast that we do after every single Monday episode. Just me and Ryan, raw thoughts, right after we record the episode. There's also the token Bible from our analysts, which is our library of research of every single good token that's out there, overweight, underweight, neutral, all the research and the catalyst. It's a living document that's updated by our regular two chat analysts at Bankless. Also, if you're a Bankless citizen, you get 30% off of to the Permissionless Conference, which means that the cost of Bankless premium just pays for itself. So now that I am done sharing my own products, let's get right into the show with E. Ty Vinik to answer the question, can the Fed thread the needle? But first, we've got to talk about our lovely sponsors who make this show possible,

• 2:55David Hoffman?

  especially Kraken, who not only makes this show possible, but also makes buying Bitcoin and Ether possible, because if you've been listening to all of this banking crisis episodes that we've been doing recently, the time to buy a non-sovereign store or value asset is perhaps now. So make sure you use Kraken when it comes time to buy your non-banking crypto asset of choice. Kraken has been a leader in the crypto industry for the last 12 years. Dedicated to accelerating the global adoption of crypto, Kraken puts an emphasis on security, transparency, and client support, which is why over 9 million clients have come to love Kraken's products. Whether you're a beginner or a pro, the Kraken UX is simple, intuitive, and frictionless, making the Kraken app a great place for all to get involved and learn about crypto.

• 3:39David Hoffman?

  For those with experience, the redesigned Kraken Pro app and web experience is completely customizable to your trading needs, integrating key trading features into one seamless interface. Kraken has a 24/7/365 client support team that is globally recognized. Kraken support is available wherever, whenever you need them, by phone, chat, or email. And for all of you NFT-ers out there, the brand-new Kraken NFT Beta platform gives you the best NFT trading experience possible. Rarity rankings, no gas fees, and the ability to buy an NFT straight with cash. Does your crypto exchange prioritize its customers the way that Kraken does? And if not, sign up with Kraken at kraken.com/bankless.

• 4:18David Hoffman?

  Arbitrum One is pioneering the world of secure Ethereum scalability and is continuing to accelerate the Web3 landscape. Hundreds of projects have already deployed on Arbitrum One, producing flourishing DeFi and NFT ecosystems. With the recent addition of Arbitrum Nova, gaming and social dApps like Reddit are also now calling Arbitrum home. Both Arbitrum One and Nova leverage the security and decentralization of Ethereum and provide a builder experience that's intuitive, familiar, and fully EVM-compatible. On Arbitrum, both builders and users will experience faster transaction speeds with significantly lower gas fees. With Arbitrum's recent migration to Arbitrum Nitro, it's also now 10 times faster than before. Visit arbitrum.io, where you can join the community, dive into the developer docs, bridge your assets,

• 5:03David Hoffman?

  and start building your first app. With Arbitrum, experience Web3 development the way it was meant to be: secure, fast, cheap, and friction-free. Learning about crypto is hard, until now. Introducing MetaMask Learn, an open educational platform about crypto, Web3, self-custody, wallet management, and all the other topics needed to onboard people into this crazy world of crypto. MetaMask Learn is an interactive platform, with each lesson offering a simulation for the task at hand, giving you actual, practical experience for navigating Web3. The purpose of MetaMask Learn is to teach people the basics of self-custody and wallet security in a safe environment. And while MetaMask Learn always takes the time to define Web3-specific vocabulary, it is still a jargon-free experience for the crypto-curious user. Friendly, not scary.

• 5:48David Hoffman?

  MetaMask Learn is available in 10 languages, with more to be added soon, and it's meant to cater to a global Web3 audience. So, are you tired of having to explain crypto concepts to your friends? Go to learn.meta mask.io and add MetaMask Learn to your guides to get onboarded into the world of Web3. Bankless Nation, I want to introduce you to Eti Vinik. He is the co-founder and chief investment officer at Equi, an alternative investment platform that brings sophisticated investment strategies to accredited investors. And Eti has been on Bankless once before, and of course, the goal of Equi is to make non-correlated investment strategies accessible to as many people as possible. The last time we had Eti on Bankless, it was December of 2022.

• 6:31David Hoffman?

  And back then, things were kind of dark, I would say. Post-FTX, crypto hadn't recovered yet. Fed still looks like it was gonna continue to punch us in the stomach over and over again. And so we are bringing him back on today to ask, perhaps, has anything changed as it relates to the Fed policy, to the United States economy, and also perhaps our beloved risk assets as well. Eti, welcome back to the show.

• 6:58Speaker 01

  Thank you so much for having me. It's a pleasure to be back here.

• 7:01David Hoffman?

  Like I said, Eti, the last time we brought you on, December of 2022, there were four main points of conversation, four main themes that we had, four main questions. The first was, how did we get here, here being wrecked, at least in risk assets, but also with just high interest rates and no end in sight for the Fed raising interest rates. And then the next question is, where are we now in the crypto land, in the status of the United States economy? The third was, when do we pivot? And the fourth was, is this the end? And at least for these last two, I remember the answer being, no, this isn't the end. But it does seem close. And in the conclusion of that episode is that you estimated some

• 7:45David Hoffman?

  sort of pivot, some sort of revitalization of the stock market, equities, even perhaps risk assets, sometime around the middle of 2023. So here we are in early April, and it's about that time to start to revitalize this conversation, return to this conversation. So to start this conversation off, before we get into your updated April 2023 slides, is there any sort of reflection or anything you want to say about that snapshot in time that we talked about last December?

• 8:15Speaker 01

  Yeah, I think it was really interesting, and things have pretty much progressed with a long expectations, in a way. It's typical that Fed hiking policies break something. We didn't know what that something would look like at that time. But we knew it's going to go, if you recall, we talked about it going from crypto world at that time, FTX, and the liking into the real world. And now, you know, we've, we're behind SVB, Signature Bank, and potentially others. So we've seen that leak going here. And I think now is really the most interesting time. As you know, what that old quote used to say, that

• 8:58Speaker 01

  sometimes years happen in weeks. I think we're approaching one of those times in the economic cycle.

• 9:04David Hoffman?

  Right now we are, you think?

• 9:06Speaker 01

  I think, yeah, I think within the balance of this year is going to be incredibly interesting as many inflection points in macro pointing to a really unique N23.

• 9:17David Hoffman?

  Okay, so before we get into again, the updated slides that you have for us and the updated perspective that you're going to bring to the table here in this episode, I just want to provide a little bit of context for listeners about who you are, your skillset, your background, and also what Equi is and why we have so many fantastic things to look at, just to provide some context for listeners. So let's start with that. Who are you, Eti? And then also, what is Equi and what does it do?

• 9:42Speaker 01

  Yeah, so I'm the CIO, Chief Investment Officer and co-founder here at Equi. Equi is basically a digital tech platform that enables an accredited investor with a relatively low dollar amount to build a diversified portfolio of many alternatives, various types of, let's say, hedge fund strategies, credit strategies, other things that are not necessarily correlated with the stock and bond world. And I think in these type of times, it's one of the more unique things you can invest in. And obviously, I wouldn't be doing it otherwise, but I think there's a greater need for diversification outside of the traditional investing world.

• 10:19David Hoffman?

  And actually, the way that this second show came about was I ran into your co-founder and he was talking about, just, he said that you had some perhaps doom and gloom as it relates to the Federal Reserve. So we'll get into that as well. But can you just like, give a preview of the performance of what some of these products that you have for and like the composition of them, just so we can understand the base?

• 10:47Speaker 01

  Yeah, so the broader type of Equi portfolio has 13 to 15 diversified investments. Some of them are somewhat correlated to markets but capture a higher beta, some of them are not. We initiated what we call Equihedge in February of 2022 when we saw that correlation picked up, even across managers that are not supposed to be correlated as a way to somewhat offset risk even more. So in 2022, which I believe was one of the most challenging investing years, really since the gold financial market crisis in 08, our flagship growth and income fund was slightly positive, about positive 1% with very low beta and correlation.

• 11:26Speaker 01

  The more aggressive growth fund was flat to maybe negative 40 or 50 basis points or something of that nature. So flat performance, I would say in 2022 for the broader flagship, is something to be proud of in a year where the 60-40 portfolio is down nearly 20%. Treasuries are down, crypto is down at 70%, gold is down, like everything was down, there was almost nowhere to hide. So proud of that fact. We also have a fund that we manage internally as well that is a tactical macro fund based on the macro calls. That was actually up around 20% for 2022.

• 12:04David Hoffman?

  Okay, so I don't know if I represent the archetype of bankless listeners, but bankless listeners would definitely know that more or less 100% of my personal portfolio is crypto assets. And so, starting at that base, what is the composition of, if you could just amalgamate everything, and maybe that's an unfair question, but you could like do your best. If you could just amalgamate everything, what is the composition of some of these things that we're talking about? Just so we can get some context before we go into some of these charts and slides here.

• 12:34Speaker 01

  Yeah, so the flagship fund is really a collection of various types of strategies. So you have some small business lending on one end, you know, that's backed by some collateral, all the way to macro systematic funds that would trade currencies, interest rates, things of that nature and everything in between. So it's really a very diversified basket of alternatives that we really try to keep as low correlation to risk asset as humanly possible.

• 13:03David Hoffman?

  Okay, so the average crypto person, again, I would say is heavily concentrated in crypto. And when we hear diversification, like at least a decent part of many of listeners will be like, oh yeah, different NFT collections or Bitcoin and Ether in addition to like some small caps. But so we're talking about what kind of seems to be completely opposite end of the spectrum in terms of just like what actually diversification means as in we're talking like real world, traditional markets, diversification.

• 13:31Speaker 01

  Right.

• 13:31David Hoffman?

  And so, and so this is like the right perspective to go into when we talk about some of these slides and conversations that we're about to go into, correct?

• 13:39Speaker 01

  Right. So one of the things that I think is of note is that institutions, large family offices, endowments and things of the liking, since the 1980s have been moving their portfolio more and more into alternatives and less and less into stocks and bonds. And that's actually in response to this decades-long declining interest rate environment we've been in, right? So interest rate peak in the 81, 82, in the mid double digits on the 10-year Treasury and have been going down towards zero in 2020. Now they've gone back up towards 4%, but as you're getting less juice from bonds and also valuations have gone, become very rich with that. Most of these institutions have shifted their portfolio into alts, you know, 50%

• 14:24Speaker 01

  all the way to 80% in some family offices. And the traditional retail investor just doesn't have access to any of those. So that's really the mission behind that. We did, we thought that bringing that type of portfolio to the average investor is something that we believe the market is, is looking for.

• 14:40David Hoffman?

  Yeah. And when you say alts, you're not meaning alt layer ones or crypto alt tokens, right? These are again, alternative asset classes, correct?

• 14:50Speaker 01

  And particularly strategies. So even, even when you dig into that, not all alts are created equal. There is a huge difference between the top 5, 10% of outperformers and the bottom of the pile. And there's a ton of funds out there that are just buying risk assets and charging a high fee for that. So those are not the ones we're looking for. We're looking for unique strategies. We're looking for differentiation. We're looking for much lower correlation than traditional assets. So it's a big difference between I own stocks, bonds and crypto, and I have all these different hedge fund strategies that each one does something totally different.

• 15:24David Hoffman?

  Right, okay, so I hope that was helpful for Bankless listeners and myself to really understand where you're coming from and where your expertise lies. And I hope that can just be good context for as we go through some of these conversations. So like I said last time in December of 2020, when we had you on, there were four main questions. How did we get here? Where are we now? When do we pivot? Is this the end? Eti, I believe you're coming to the table with four new questions. So maybe it's time to break open the slides and we can start to talk about these high level discussions that we're going to go through today.

• 15:55Speaker 01

  Yeah, let's dig, let's dig right in. So starting this, the topics for today, we're going to talk a little bit about the macro environment and the overview of what led to these bank collapses that we've heard about. The biggest question again is, do the bank failures actually make the Fed pivot? As of the last few weeks, at least, it seems like the market is convinced that that is the case. We'll dig into that and see whether or not that is true. We'll talk about the positioning in the current economic environment, some of the future of the banking system. And generally, we're still going to try to answer the question of whether or not we're going to have the soft landing, hard landing, or catastrophic landing, because regardless of the Fed pivot, that is actually going to guide the prices

• 16:39Speaker 01

  of risk assets even more so. There's a lot of dependency on the Fed, but the Fed is not the only game in town.

• 16:47David Hoffman?

  Okay, beautiful. And I remember the last conversation, this also is where this started and ended, is soft landing, hard landing versus catastrophic landing. I think that's kind of the overarching theme here is, can the Fed thread the needle? And so, Eti, if you could just like run back us in time to December of 2022, when we last had you on versus where we are now, did the ability for the Fed to thread the needle and get us to a soft landing, no recession, but below trend to go, that's fine. Did that needle get bigger or smaller?

• 17:22Speaker 01

  I think their job has become incrementally more difficult.

• 17:25David Hoffman?

  Okay, incrementally, not crazily, just as a little bit.

• 17:29Speaker 01

  Yeah, so as you know, things have not, we have the suspicion that some things are going to crack. Some things have cracked, but to be fair, SVB and Credit Suisse that have been in a decline for a long period of time are not, you know, are not huge issues right now in the economy. There are issues with the smaller banking system in general and other things like that, but this is not systemic risk right now, but that doesn't mean it can't develop into systemic risk later.

• 17:57David Hoffman?

  Okay, well, so back in time, I remember it's like, I understood that when FTX collapsed, I was like, this is not going to be the crack that they're looking for. Much of the people in the crypto industry are like, oh, the banking sector is going under. This is clearly the thing, the signal that the Fed needs to back off. And what you're saying is like, maybe that's not the case. Just what's the rationale for that not being the case, just once more time?

• 18:22Speaker 01

  Yeah, so the rationale is that inflation and employment, which are the two main mandates for the Fed, are really what you need to watch for. We have some slides talking about both, but as of right now, at least, employment, which is a lagging indicator, is still fairly strong and inflation is still high and is much stickier than was predicted before. In December, if you recall, we talked about inflation likely becoming stickier and longer than the market expects, and that's exactly how that actually played out. So you can make the argument that the Fed has reacted aggressively to this banking crisis because they are looking to still fight inflation. So, you know, it's almost like you, you turn a fire with one bucket, but then you light

• 19:06Speaker 01

  a fire with somewhere else.

• 19:09David Hoffman?

  Okay, beautiful. All right, so where did this conversation start? Where are we going to inject ourselves into this conversation?

• 19:15Speaker 01

  Yeah, so I wanted to just talk about the wealth destruction that already took place just to give you some context of, you know, last time we gave a much bigger history of how did we get here. I want to keep this a little bit shorter. But generally, in total dollars, so of course, this is not adjusted for inflation and it's a little exaggerated for that reason. But this has been the largest dollar wealth destruction that we've seen thus far, particularly because bonds in 2022, which have traditionally been this diversifier, typically uncorrelated with other risk assets, have crashed just as much as stocks and even more, which is relatively unusual, but that's because interest rates

• 19:58Speaker 01

  were so low and we've seen the fastest rate cycle increase since Volcker, really, in 1980s. So massive wealth destruction. For those of us that like these type of, you know, I come from the startup world as well, right, as you run, raise money from a VC, you know, this will look very similar to the chart of ARK Investments as well and probably the chart of crypto as well. The nonprofitable tech index, really. So nonprofitable companies, it's the same, it's the same idea as borrowing money on some kind of interest rate because you can think of these companies as living on a credit card. When money is very cheap,

• 20:40Speaker 01

  they tend to do very well. When money is more expensive, it's a much more challenging environment. Post-COVID, huge boom. 2022, huge bust. The biggest problem when you think about these types of assets is the negative compounding of loss. So I'm going to remind everyone here that risk management is even more important than capturing all the gains. Because if you lose 90% on any asset, you need to make 1,000% return in order to get your money back, right? You need a 10x return. If you lose 50% of your money, you need to double it up. You need to make 100%. So the net, the net conclusion is that you need to avoid losing large amounts of money when possible. So just a little reminder of that.

• 21:24David Hoffman?

  So just to rearticulate that, you're saying that it is more important to preserve wealth than it is to gain wealth after you've already gained wealth?

• 21:34Speaker 01

  I believe so. I believe so exactly for that reason. So you know, when you're down 76% or in this case, I think it was 90%, this 20, 30%, 40% increase is almost irrelevant because you're still down 76% for the top. You know, once you lose 90%, it's very difficult to make a 10x.

• 21:53David Hoffman?

  Right, certainly. And I really like this, this chart that we're looking at, non-profitable tech index. And for those podcast listeners, it doesn't look exactly like the crypto market cap chart. There's a little bit of deviation there, but man, you can really see it. And I think what you're really saying here, Eta, is that this chart in particular is like an amalgamation of the non-profitable tech sector. And I mean, a large amount of like what crypto resembles to be is like, it only kind of works in a low interest rate environment. And so this chart that I'm looking at here kind of feels just like the archetype of the long tail risk asset, YOLO money kind of paradigm that we went through, both in

• 22:38David Hoffman?

  equities market and the crypto market in the 2021 bull market. That's a funny way, fun way to interpret this chart, right? Like it's an archetype of all of the casino that was 2021.

• 22:50Speaker 01

  You're exactly right. And that casino was not only confined to public markets, also to private markets. So to give you some ideas of what happened to startup and tech evaluations in the private markets, Series A down 50%, Series B down 74%, Series C down 87%, Series D up to 92% decline. It's just staggering.

• 23:14David Hoffman?

  And so these are companies that have already raised, where this is not like an average of just like the total amount spent. These are companies that have benchmarks that we can compare to. And you're saying that Series D valuations, which is usually the fourth, fifth, depending on seed rounds, the fourth or fifth raise for a venture for a startup, and that is on average is down 92%.

• 23:39Speaker 01

  Wow. Yeah. So it just gives you a little bit of a magnitude of the bubble that we've seen in 2021, which I'll talk a little bit about more. I think 2022 was not a traditional bear market in multiple senses. I think it's more of a rerating cycle wherein the economy is still strong, but valuations were just too high for the current interest rate environment. They were changing. So the market rerated. The question now is whether or not we're going into a traditional bear market once the rerating was complete, or are we going to stabilize? That's more or less where I'm at. I think the rerating part is more or less complete.

• 24:15David Hoffman?

  And so the rerating, this word, I think, maybe perhaps another way to say this is that we should never really, we shouldn't consider the 2022 decline in crypto asset prices or asset prices in general as a bear market. You're just saying that like, we should never have assumed them to have established that high in 2021 in the first place, right?

• 24:33Speaker 01

  Correct. It only made sense in the context of zero interest rates, money printing, and hot money chasing assets. But if you think about it in the context of longer term valuations, it never made sense to begin with.

• 24:46David Hoffman?

  Okay, so does that mean that the question of if bear market? I remember asking like, are we in a bear market on bankless? Like over and over and over again through 2022 and then towards the end of 22, like, oh yeah, this is a bear market. But I think what you're perhaps saying is like, no, the question to ask that question is now, not now's the time?

• 25:04Speaker 01

  That is exactly right. I look at the entirety of 2022 as a rerating cycle. And mainly because in normal, generic bear markets, the yield curve inverts ahead of the bear market here. Or the yield curve starts to disinvert as you go into the bear market. That actually didn't happen. Yield curve massively inverted while stocks were going down. But also the bond market has declined alongside with stocks. So everything got rerated. And really, what we've seen over the past few weeks is some deviation in correlation. So for the first time in a while, we've seen bonds actually rise as equities were falling. Correlations were starting to break with the dollar as well. And the yield curve went from negative 100 back to minus 50 basis points.

• 25:48Speaker 01

  All signs of a potential coming recession or bear market. Those were the classic things that were happening ahead of an actual bear market. So again, the question is, you know, is 2022 even a bear market? Or just basically adjustment of prices to higher interest rates?

• 26:04David Hoffman?

  Okay, that's an interesting perspective where we just are coming back to reality throughout 2022. And now the big question is like, okay, what is the economy's reaction to that rerating? And is that reaction a bear market? And what you're saying is like, some of the indications are like, yeah, it could be a bear market.

• 26:23Speaker 01

  But the economy itself remained resilient. Employers were still hiring. Unemployment didn't really pick up that much in 2022. And even though inflation was high, the economy and consumer spending were still strong and GDP was positive. So in the classic sense, it wasn't a bear market at all.

• 26:42David Hoffman?

  Hmm, okay. I might be getting the hint that this is slightly different now, but let's keep going in your flow of slides here.

• 26:50Speaker 01

  Yeah, so bank failures, Fed always breaks something. Every hiking cycle, something breaks. This is something we brought on the last call. Clearly don't always know what it is that's going to break. But the takeaway here is really that once something starts happening and starts breaking, it can accelerate incredibly quickly. So if you go back to March, Silvergate said they will cease operations on March 8. And by March 10, SVB is already failing. And by March 19, Credit Suisse was failing. So S and B, the Swiss National Bank, actually said, I believe yesterday or the day before,

• 27:32Speaker 01

  they were saying that it would have taken just a single more trading day for Credit Suisse to have completely defaulted. So things can accelerate quite a bit. That's why we've seen this very fast response from the Fed and the S and B. All these actions with the discount window, we're going to talk about that because I think they're actually really important to understand the mechanics of how these things work in the greater context of risk assets.

• 28:01David Hoffman?

  Okay, and so, God, that's scary. So March 8, Silvergate, which was before what we call the banking crisis, just Silvergate announced that it would cease operations. 11 days later, Credit Suisse says that it's one day away from complete failure.

• 28:15Speaker 01

  That's right.

• 28:16David Hoffman?

  Yeah.

• 28:18David Hoffman?

  It's always crazy to see how like fast, this is all like hive mind stuff, right? This all exists in the perception layer of humans and that can of course go as fast as the internet these days.

• 28:28Speaker 01

  Right, and you know, this explains the very aggressive policy response and.

• 28:36Speaker 01

  Very interestingly, risk assets took that as a very bullish sign of liquidity and have been running since around March 19th to the upside. And I think one of the, one of the things we really have to consider is, does this actually mean that the bottom is in and liquidity is improving or not? And this is just another one of these vicious bear market rallies that suck everybody in, but then it's about to make lower lows. And I'll try to answer that today.

• 29:05David Hoffman?

  Cool. All right. Let's keep on going.

• 29:08Speaker 01

  So I think the driver of all these things at the end of the day is just money, right? Do you have more money or do you have less money? And ultimately, that impacts the pricing of most assets. So 2022 and into 2023 is actually the first time that we've seen that money growth itself, M2 money supply is negative on a year-over-year basis. We've seen this enormous wall of money come in out of COVID, which really fueled inflation and risk assets and Bitcoin and tech stocks and all these things. And now we're seeing that going negative. And at the same time, you see that money supply here on the top chart. This is the total M2 in the United States, M2

• 29:53Speaker 01

  broader definition money supply. And you can see how correlated it is with bank deposits. So there is this very interesting narrative taking place where if you have money in depository accounts, the banks can't afford to pay you what the prevailing interest rate is for various reasons. Inverted yield curve is one of them, other liabilities, et cetera. So why are you keeping your money at the bank? Wouldn't you be better off putting your cash in a short-term treasury earning 5%?

• 30:26David Hoffman?

  Certainly.

• 30:27Speaker 01

  Taking no risk, no FDIC insurance, right? So more people are understanding that money is moving away from banks, but clearly the smaller banks are suffering a lot more than the big banks. But this is all a function of the money supply itself. There's just simply a decrease in the money supply as a result of the Fed's quantitative tightening.

• 30:47David Hoffman?

  Really quickly on this, my interpretation of this, and just to correct me if I'm wrong, is that people are moving their money, and we've talked about this particular theme on Bankless, people are moving their money out of banks into money markets because that is where they get their yield. Jim Bianco called this like trad-fi yield farming. Why this is significant is that when we take our money out of banks and into money markets, we are destroying credit because those banks can't lend that money out, and therefore we are reducing M2, and that is a deflationary pressure on the economy. Is that the meaning that we should derive from this?

• 31:21Speaker 01

  That's very fair, but also M2 itself is declining as a result of the Fed's actions of quantitative tightening. So in this chart, you can see what's going on. So what is quantitative tightening? It's the exact opposite of quantitative easing. So during the periods of the easing in 2020, 2021, and really after '08 as well, '09 through really 2018, the Fed was creating money out of thin air and using that money to purchase US Treasuries, therefore increasing the amount of liquidity in the economy. But what you're seeing here is that starting in 2022, that actually went in reverse. So instead of creating money out of thin air and buying Treasuries, as these Treasuries mature, the Fed is receiving its principal back.

• 32:06Speaker 01

  So right, if you buy a Treasury, you get a coupon rate, and then at the end of the period, you get your money back, which is your principal. So in this case, the Fed is getting their principal back from the Treasury. Which is the money they created and they click the delete button and simply destroy it. So there's just straight up less money in the economy.

• 32:22David Hoffman?

  And there's no sign of that ending and that's supposed to be the status quo moving forward. And so the idea is that for bankless listeners that weren't able to see that last slide, we're seeing growth in M2 money supply over the last like four decades. And now it's starting to like turn over and finally go negative for the first time ever. And what you're saying, Eta, is that that's probably going to continue. Is that right?

• 32:42Speaker 01

  That's probably going to continue. The Fed has not said that they're going to stop that, but some interesting things have happened. So this is the Fed balance sheet going back to 1995. It correlates incredibly well with risk assets. You see the first quantitative easing starts coming out of 08, being halted, markets crash in 2010, comes back again, halted, markets crash again in 2011, US credit gets downgraded, August 2011, markets down 20%, QE comes back. Every time the Fed needs to do a bigger and bigger QE in order to pump things up again. And then the really big one happens after COVID, basically almost doubling everything that was done up until that point. The balance sheet reaches almost

• 33:25Speaker 01

  10 trillion, 9 trillion and change. And then the tightening starts. All this damage in the market was just during this period of tightening. However, over the last two weeks, there has been a big jump in the Fed's balance sheet as a result of the support that the Fed is giving banks to the discount window. So I've heard this question asked numerous times from many people over the last two weeks. They're asking me, is this basically stealth QE that's going on? Is the market responding to this stealth QE? Is crypto jumping all this on the stealth QE? And is this going to continue?

• 33:57David Hoffman?

  Right. Yes. And this is of course, the bank term funding program that we've talked about. And the last, the last, and I think most coherent answer that we got is that technically it counts, but it shouldn't be considered meaningful. And it's not like the QE that we've seen before. Is this your interpretation as well?

• 34:15Speaker 01

  Might, yeah, I agree with that interpretation. And I would even add that I think it's actually worse. So I think in a way, I think in a way, it could be, it could create further issues in the system when this actually gets paid back, because it's expensive money, unlike QE, which is very cheap money. And that could create some issues. So what you're seeing here in this chart, going back to 2003, is the total amount of discount window borrowing that's taking place. This is 08. That's COVID and this is the 153 billion jump we've seen in three days just to to cover the reserves. And this is obviously showing up on the Fed's balance sheet as it

• 34:55Speaker 01

  is borrowing. But this is a sign of financial stress in the system nonetheless, because banks are pretty desperate that they have to do this.

• 35:03David Hoffman?

  This this is spike. So just for the podcast listeners, we have this 08 spike, which is decently large, maybe two thirds way up the page, and also has some decent area under the curve. But then it goes back down and stays flat until we see COVID. And then COVID happens and it's a small spike, maybe a third of the size of the 08 spike. And then here we are today with the bank term funding program. And that is a insanely vertical line all the way up to the top of the graph, which is maybe a third larger than than 2008. And what you're saying, Etya, is that this is a sign of distress. And so maybe the the naive bull person is like, this is QE. Here we go. Look how fast that thing's going up. And what you're saying is like, you know, let's tamp on those brakes. This is a symptom of distress.

• 35:45David Hoffman?

  And it's necessary that this spike happens, or else the banking system would collapse, correct?

• 35:50Speaker 01

  That's correct. And I'll add to it as well. This is also dependent on the prevailing interest rate that that exists. So if you think about it, there is a lending rate which banks use to lend to each other. So let's say bank number one needs money today because there's a deposit run on them. They can go to bank number two and say, okay, can you lend me money at this overnight rate and I'll pay you back. And then they change. And these banks lend to each other all the time. When these banks don't want to lend to each other because they're worried that they may be next in a bank run, for example, that creates a credit problem because the whole credit market freezes and that's the worst thing that can happen to capitalism. So then the Fed is this lender lender of last resort. The banks can go to to borrow money, but this money is not cheap. This money is at the around the Fed fund rate. So when they're borrowing this money, they're actually paying

• 36:35Speaker 01

  5% for it, right? If interest rates were zero, that would have been a very different, very different environment, right? Because then you're really borrowing for nothing. So who cares? That's real more like QE. But at a 5% rate, that's not cheap money that the banks have to carry the interest and then pay back. And potentially, they're only using this money to substitute for reserves. So I don't know if it adds net liquidity into the system, maybe for a short period of time. But there will be a time where you have to either pay it back, which will reduce the balance sheet, or the stress gets even bigger and this is just not enough to help, especially given the interest rate environment.

• 37:11David Hoffman?

  So I thought the bank term funding program was a policy to borrow from the Federal Reserve at like 10 basis points. And so you're telling me it's at 5%. What am I missing here?

• 37:22Speaker 01

  Well, this is different. This is the discount window. The borrowing program is a little bit different where they they pledge their treasuries and then they let them basically carry it up without a law. So that's that's definitely more similar to it. But there's also a lot of borrowing at the discount window.

• 37:37David Hoffman?

  Okay, so the the capital that's being created as a result of the bank term funding program is not what this spike is showing here on this chart?

• 37:45Speaker 01

  Yeah, the the discount window is direct borrowing from from the Fed.

• 37:50David Hoffman?

  From out of just necessity from banks?

• 37:53Speaker 01

  Yes.

• 37:54David Hoffman?

  And so you're saying out of necessity, these banks are taking like emergent, call it emergency credit, emergency funding at the Fed funds rate, which is like at 5%. And so they're willing to take this 5% very unfavorable rate because of how dire the situation is for for the banking sector?

• 38:09Speaker 01

  Right, or at least it was. And I think borrowing actually declined a little bit over the last few days. So the sign of stress is is dropping a little, but it's still fairly elevated. This what happened here after Lehman, when this spike went up, markets actually continued to go lower for, I think, six months until things actually calmed down. And the main idea behind why are banks in trouble, we covered this, right? When they in 2020 and 2021, when there was this big spike in deposits at the banks, they were basically getting a ton of new money creation that was being parked at the at these banks.

• 38:50Speaker 01

  And these banks basically bought treasuries with it, or 10-year treasuries, 20-year, 30-year treasuries. So the problem is, is when rates go up, bonds are inversely correlated to to rates. So the price of treasuries went down. Kind of interesting, but it happened to the Fed as well. So the Fed holds a lot of treasuries, including long-dated treasuries on its balance sheet. So the Fed, too, lost $42 billion. Not that it matters, because they're they're not a for-profit organization, but they actually, this this is actually an interesting thing because the same thing happened in the Fed as well.

• 39:22David Hoffman?

  Wait, so the banking crisis where all of these like long-term dated treasuries went south and caused the banking crisis, you're saying, well, the Fed is also a bank. They also had that on their balance sheet. They also have that problem. But it's also just not a problem when it gets to the level of the Fed because it doesn't matter because they can print money, correct?

• 39:40Speaker 01

  When you create your own currency, it doesn't matter. Yeah.

• 39:43David Hoffman?

  Okay, it doesn't matter, like, but it does, right? It does somewhere.

• 39:50Speaker 01

  Right, right. The Fed is floating this, but it's just an interesting thing to kind of know.

• 39:57David Hoffman?

  Okay, all right. So where does this conversation go next? Like, what does this actually mean for liquidity?

• 40:02Speaker 01

  Yeah, so so far, markets have reacted positively to this liquidity jump. The this offset of quantitative tightening, at least over the last two weeks, markets have jumped directly in response to it. And you can see how correlated the S and P 500 has been to the total net liquidity. So here we take the Fed balance sheet minus the Treasury account, minus reverse repo. Long story short, we're just looking at all that available liquidity out there. And markets are just correlating to that almost to perfection.

• 40:34Speaker 01

  It is important to see where this balance sheet is going and whether or not this discount window borrowing and what happens to the banking crisis continues to loosen financial conditions or not. We don't see this as actual quantitative easing right now. But that doesn't mean that can morph into it. I know this is some crypto centric podcast in here, so here we correlated the price of BTC versus that total Fed liquidity, but you can see that really strong correlation as well.

• 41:02David Hoffman?

  Okay, so you're saying that it's really, really important to understand the liquidity effects of the current environment. And and so what I'm saying, what I'm hearing is that there is new liquidity. Therefore, crypto, the extra sensitive canary in the coal mine to liquidity is jumping. What I'm, what I was worried about hearing and what I'm not hearing, and so correct me if I'm wrong, is that the market is having just like this spinal reflex of Oh, the Fed is pivoting in like the balance sheet is going up, therefore it's bullish. And I don't, I don't, I'm not seeing any signs of that being the, the market reaction. And so what I'm seeing right now is like, it actually kind of makes sense. There's more liquidity in the market, at least for now.

• 41:43David Hoffman?

  And so crypto assets and risk on assets are up like they would expect to be. That seems all normal, right?

• 41:49Speaker 01

  Right, right. But then the big question is, is this actual QE? The answer is it's probably not. So, you know, even if the banking situation improves and banks pay back the discount window, the Fed balance sheet is going to drop and the Fed is still doing quantitative tightening at the same time, which is kind of weird because you get the discount borrowing, but at the same time you have quantitative tightening. So there's a lot of counterfactors that go into it. So if I'm asked the question, are we going to go into a market like 2021 that things are just up, up in a way? I think the answer is probably no. And we're going to have a lot more chop and volatility as this situation kind of unfolds.

• 42:30David Hoffman?

  And that, that tracks with our Jim Bianco conversation, which is our most recent macro conversation where he says like, everything just see like there's bearish indicators and there's bullish indicators and they all seem to kind of cancel each other out pretty damn well. And so now the markets are confused and so we're just going to kind of go flat and chop around for a bit. Is that in line with what you're saying?

• 42:50Speaker 01

  And that's been the case, by the way, since about August of last year. Markets have just chopped around in a range and nothing really happened and a lot of money was more or less lost because people didn't know where it's going. And just that it's very risky to get chopped to a thousand pieces in this type of environment. I do believe it's going to get resolved though, one way or another in the next few months.

• 43:10David Hoffman?

  One way or another, no opinion on the direction of it getting resolved, but you do think it's going to get resolved soon?

• 43:16Speaker 01

  Well, I, I am leaning more bearish on the resolution, which I'll, I'll dig into why. So if I had to pick a direction, it would be more likely bearish, but anything can happen, right? The Fed could decide to flood us with liquidity again, and that basically throws everything out of the window. And to understand that, you know, This is one of the more liquidity sensitive sectors that I've been following for a long period of time. You can look at the micro cap index of the Russell. So you can think about this as the most liquidity sensitive stock. So let's say the big, the big stocks, the big names, they get the liquidity first, like the Apples and the Amazons and Nvidia and all these things

• 43:58Speaker 01

  that are flying right now. But there are a lot of other stocks that are much more liquidity sensitive. And typically, the stock market does best when these stocks upperform the rest of the market. We're seeing a really big divergence where the micro cap stocks didn't even, didn't even flinch on this recent move up. If you go back to December of 2021, they actually topped out in November and had a big drawdown in December while markets continued upward. That was a great warning indicator for the top. So this is actually giving us another warning sign right now. This is another way to think about it as, you know, how the market breadth looks like, how's liquidity looking like? And for the entire year-to-date gains, I think S and P is up about 7% year-to-date. This is how much of

• 44:43Speaker 01

  that value was given, driven by the 15 largest stocks, Apple, Microsoft, Google, et cetera, and their change in market cap and the entire rest of the stock market. Now, that's not a

• 44:53David Hoffman?

  This kind of feels like a similar, this is totally different, but this feels like the similar to the fact that like in the banking crisis, all of the small and medium-sized banks got worked and everything flew to safety, which was the JP Morgans, the big banks. Is this just the same effect happening with the stock market at large?

• 45:09Speaker 01

  Yeah, and it's not healthy. History shows us that when a rally in the market is very concentrated in a few names, it typically doesn't hold for a long period of time. So that's just something to consider. When a rally is very widespread, and that means the whole economy as a whole is doing better. So it's led by 300 stocks. That means there's good economic environment all around the board. So that's a good sign. But when only a few stocks are leading it this flight, the quality is not necessarily a good sign.

• 45:39David Hoffman?

  Okay, so you're adding just one more data point to the perhaps temporal nature of the recent run up in maybe crypto asset prices, the recent perception of liquidity. You're just saying like, hey, man, there's a, there's a lot of temporary indicators out there that might not stick around. You know Uniswap as the world's largest DEX with over 1.4 trillion dollars in trading volume, but it's so much more. Uniswap Labs builds products that lets you buy, sell, and use your self custody digital assets in a safe, simple, and secure way. Uniswap can never take control or misuse your funds the bankless way. With Uniswap, you can go directly to DeFi and buy crypto with your card or bank account on the Ethereum Layer 1 or Layer 2s.

• 46:22David Hoffman?

  You can also swap tokens at the best possible prices on uniswap.org. And you can also find the lowest floor price and trade NFTs across more than seven different marketplaces with Uniswap's NFT aggregator. And coming soon, you'll be able to self custody your assets with Uniswap's new mobile wallet. So go bankless with one of the most trusted names in DeFi by going to uniswap.org today to buy, sell, or swap tokens and NFTs. The Phantom Wallet is coming to Ethereum. The number one wallet on Solana is bringing its millions of users and beloved UX to Ethereum and Polygon. If you haven't used Phantom before, you've been missing out. Phantom was one of the first wallets to pioneer Solana staking inside the wallet and will be offering similar staking features for Ethereum and Polygon.

• 47:05David Hoffman?

  But that's just staking. Phantom is also the best home for your NFTs. Phantom has a complete set of features to optimize your NFT experience. Pin your favorites, hide the uglies, remove the spam, and also manage your NFT sale listings from inside the wallet. Phantom is of course a multi-chain wallet, but it makes chain management easy, displaying your transactions in a human readable format with automatic warnings for malicious transactions or phishing websites. Phantom has already saved over 20,000 users from getting scammed or hacked. So get on the Phantom waitlist and be one of the first to access the multi-chain beta. There's a link in the show notes, or you can go to phantom.app/ waitlist to get access in late February. Let's answer your question.

• 47:45David Hoffman?

  Yeah. Does this force a Fed pivot? Now is the time. And I'm already worried about the answer, but E-Tai, give it to me.

• 47:54Speaker 01

  Yeah, so just to get this idea, this is not just the Fed phenomenon, it's a global phenomenon as well. The ECB just raised rates 50 bips in March 16, and that was despite what just happened in the market. And the Fed also raised rates by 25 bips after what happened to SBD. So the Fed and the ECB had an opportunity to make an immediate pivot already, and they didn't. So the question is, does that actually mean that we're going to get a pivot or not? You can see where rates are now, close to 5% across the developed world after a decade plus of being around zero. And the context of, you know, longer term history, clearly, we're not going to go back to the 1980s.

• 48:38Speaker 01

  And right now, the market seems to think that the Fed pivot is imminent. So what you're seeing in this graph, quite an interesting graph, is called the Fed dot plot. This is released a few times a year during FOMC meetings, Federal Open Market Committee. And what is going on here is that each member of the Fed gets a dot. So that's where they vote of where interest rates are going to be in the future. So that's 2023, 2024, 2025. So there's a lot of consensus around the dots that rates are going to be somewhere between 5 and 1/4 and 5 and 1/2%, where most members of the FOMC believe that's where things are going to land.

• 49:21Speaker 01

  And then there's a lot more divergence into 2024. You can see the dots are all over the place. However, the market is substantially below where the Fed dot plot is. Kind of believing that rates are going to get cut drastically this year, where the Fed said it is unlikely during their last meeting. So it's an interesting place to be right now, where market is pricing the Fed completely pivoting, and the Fed is not acknowledging that as of yet. So betting on the Fed pivoting is somewhat uncertain right now.

• 49:55Speaker 01

  You can see that here too, number of rate cuts. If you go back to early March, Jay Powell actually made a a speech to the Senate right before SBB collapsed that week, saying that we need to be more hawkish for longer. And that that was blown off through the window right, right, right away. So market seems to believe a pivot is imminent as of May, and cutting is aggressive, cutting is coming in. And we're probably going to get cut three, four times by the end of the year.

• 50:26David Hoffman?

  Okay, so you're saying the market is positioned for this case?

• 50:30Speaker 01

  Correct.

• 50:30David Hoffman?

  And as would the interpretation that we can get from the Fed, the Fed dot plot, the is that those things are not necessarily lining up?

• 50:38Speaker 01

  Yeah, so the Fed Fund Futures is pricing in a full on pivot. The yield curve as well, so the yield curve got to negative 100 basis points. So that's the spread between the two year Treasury and the 10 year Treasury. And that went from minus 100 to minus 50, which indicates that the two year Treasury has declined, which means the market is now expecting lower rates on the two year time horizon. And, you know, that is an indication of the pivot as well, because the yield curve starts disinverting when the pivot gets closer and potentially also signaling a recession. Here's my problem with the Fed pivot narrative.

• 51:14David Hoffman?

  Okay. Tell me the bad news, Doc.

• 51:16Speaker 01

  Which I'll break. Kyle has consistently said, and you can go back and read what he was saying in various meetings, that he is very worried about services inflation particularly. And we are, we talked about this in December as well. We're saying, look, the, the, the services inflation is the stickiest part. And that's the, what we really need to watch for. Because once that goes up, it's very difficult for it to go down. You know, once your, your barber increases their, their price by $5, it's not going back down. And that continues to happen. So there's literally no evidence whatsoever of services inflation slowing down. In fact, that's the dark blue here below.

• 51:58Speaker 01

  It's become the largest component in inflation. So inflation has come down, but that has come from energy prices and a little bit of food prices and commodity prices, but services, the stickiest part is continues to go up.

• 52:12David Hoffman?

  And looking at this chart, everything else seems to be able to flex up and down, at least by just the nature of the chart. And the the services is pretty linear and kind of just looks very, very like like a straight arrow.

• 52:28Speaker 01

  Right. And we've even gotten some bad news over the last two days. OPEC decided to cut a million dollars, a million barrels a day of production. And oil prices shot up eight or nine percent back to $80 a barrel. So you're probably going to get some of the commodity inflation back in. Food inflation has gone back up. So there's no evidence that inflation has died yet. So, you know, this talk about a Fed pivot, I think, may be a little premature until we see some real signs of either the labor market collapsing, which will force the Fed to stop, or inflation slowing down, but I just don't see it.

• 53:02David Hoffman?

  Right. So maybe one way to to perceive this is that like there is, and maybe I'm just learning about macro like live here. There's like this part of inflation that flexes quickly. And then there's this part of this inflation that doesn't flex so much that maybe that's what core is. Maybe that's why we use the word core.

• 53:21Speaker 01

  That's what services is. Yeah. So like services is prices paid for goods and services, wages, things of that nature, where you have the more transitory part, which is energy prices, commodity prices, and things that fluctuate with the market.

• 53:33David Hoffman?

  And so inflation has come down because that transitory part in inflation has come down. Yet the services part, the stickier part, is not yet responding to rise to the rising interest rates.

• 53:44Speaker 01

  That's exactly.

• 53:45David Hoffman?

  This is this, and along with everything else that you've talked about is, I mean, maybe we're jumping into the conclusion here, but like kind of why you're saying like, yo, let's not get overly, let's not make our sentiment overly bullish here.

• 53:57Speaker 01

  Right. Until we see inflation really coming down, the risk that we're running is actually stagflation. So the risk that we're running is prices remain high, but the economy starts deteriorating and the Fed is stuck and unable to pivot. That is kind of the worst case scenario.

• 54:13David Hoffman?

  And are we heading for that scenario?

• 54:16Speaker 01

  It's possible. Energy prices have calmed down, goods inflation, not going to stall too much about this. But to your point about the pivot, there is this assumption that the pivot's actually always going to be positive for risk assets, but that's not even necessarily true, because it depends whether or not the pivot was too late, right? There's two cases. Pivot happens right before we go into a recession, or pivot happens when we're already in a recession, and the Fed is just late. And you see these instances, 1995, 98, 2019, in blue, markets and risk assets respond positively. This is measured by S and P 500. But in 1989, 2001,

• 54:58Speaker 01

  2007, we were already in a recession when the pivot happened, and one year later, things were substantially worse. So even this notion of whether or not a pivot happens, you have to put a lens on it and say, is the pivot actually happening in time or not? Is it too late? Because remember, monetary policy was in the lag.

• 55:18David Hoffman?

  Right. And so this brings us to the question, where are we as it relates to a recession? First, how sure are you that we have a recession happening? And if the answer is yes, which I'm guessing the answer might be yes, where are we in relation to that?

• 55:32Speaker 01

  Yeah, so I think about 60, 70% confidence recession is coming very soon. Basically, the yield curve, when it starts disinverting, tells us that it's usually within a few months already. We know we're going to have below trend growth. Nowcast GDP has come down substantially. So, you know, I think it's a matter of, towards the end of the year, GDP estimates are now showing one of the largest deceleration in real economic activity of all time, when you're looking at real GDP, so just for inflation. And we're seeing the consumer also not being in great shape as well. So GDP estimates are

• 56:15Speaker 01

  For 2023, have somewhat been revised up, but the period is showing below trend growth. So I think until we start getting real negative numbers and real unemployment figures increasing. Today, actually, was interesting because we've seen some deterioration in the labor market, but not enough to tell us that a recession is here. But I think it is likely to be here soon. So that chart, I think, is somewhat interesting, where we've seen, on one hand, since September of 21, we have seen core inflation projections increasing and growth projection decreasing. So that is potentially very stagflationary. Right.

• 56:59Speaker 01

  And here's what really worries me is the consumer, right? So US economy is very consumption based. I believe about 70% of it is direct consumption.

• 57:12Speaker 01

  And there were some positive things happening during COVID, because people are actually paying credit card balances quite a bit. So they're getting all this stimulus checks and unemployment benefits, and they didn't have anything to spend them on because everything was shut down. So just basically paying off these credit card balances. However, with inflation being as high as it is and cost of living exploding post pandemic, we're at a new cycle for credit card debt, while credit card rates are really high. And one of the issues that we're seeing is that the personal savings rate on average is far below pre-pandemic levels now. And we're seeing this big deterioration in bank deposits,

• 57:56Speaker 01

  which some of it could, you know, obviously be moving to higher rates. But other explanation is that there's more need for cash and liquidity. It's quite interesting. Here's that first stimulus check, and this is actually the second one.

• 58:11David Hoffman?

  Right, right, right, right. Yeah, so going back to that credit card outstanding debt, like there's a, it's an upwards trend up into the right. Then we get the stimmys and people pay off their credit cards. So there's a big dip, but if you just ignore that dip and put your hand over it, we're back up to the point where that line just might as well have gone straight. And sadly, the net effect of rates as a result of inflation is that, okay, we've continued on this trend, words up and up into the right for credit. And also rates are higher than they've ever been. So not only is the debt outstanding super high, the rates are also super high. And then on the next slide that we're looking at, we're looking at personal savings and bank deposits at all time lows. And so this is, this is what you are indicating as in like, oh, we're kind of on the,

• 58:54David Hoffman?

  this is the ingredients for a recession, plain and simple.

• 58:58Speaker 01

  Yeah, so what worries me is that if layoffs now start en masse, the cushion to tolerate those layoffs and be able to spend and keep the economy floating is just, there's not, not great. It's just not there. So you can have Goldilocks in reverse where people get laid off, then they spend less and then more layoffs occur because, you know, the companies are not making as much money and margins drop and all these things can happen. So that's really what worries me about that. And the fact that if the Fed needs to ease, it needs to be now. But with inflation being where it is and sticky as it is, it's just going to be very difficult for them to do it.

• 59:37David Hoffman?

  Okay, what else, what else other bad news do you have for us?

• 59:42Speaker 01

  Well, it's interesting. Retail sales has dropped, but it's still relatively strong. An explanation to that is obviously the cost of living is higher. So people need to spend more to do it. So this is something we're watching for as again, we are in a consumption, consumer led economy, we want to watch how retail sales set up. And labor is one of the most important factors. This is one of my favorite indicators here, looking at risk asset versus the employment numbers.

• 1:00:13Speaker 01

  So the trend of employment, putting a simple five-month moving average on it, shows the turning points in a really good way. I think COVID is a little bit of an abbreviation because a lot of people were not really laid off because they still got money and they still spend it. But you can see here in the classic recessions, in 2000, the softening in the labor market corresponds perfectly with the bear market, then the bull market corresponds perfectly with the rising employment, again, 08, 09, softening labor market, down stock market. So when that turn, when that line starts turning back up, you're in a persistent bull market for a very long period of time, and you got this COVID situation. So now what I'm watching for is, does unemployment

• 1:00:56Speaker 01

  start rolling over? So what I mean is this period of 2022, that's a rerating, right? Because technically, we should be in a bull market, but we're not. So that's a rerating. So do we go into the real bear market, the real recession, if this line starts rolling over? And then you get the actual bear market part of it, and that's really what I'm watching for.

• 1:01:15David Hoffman?

  Okay, okay. How, what indications do we have? Or is that, is that an impossible question to answer?

• 1:01:24Speaker 01

  Yeah, so manufacturing is one of the first things to go into contraction territory because that's, that's sensitive, and that's already fallen into contraction territory. LEI is what we call leading economic indicators. So this is multiple indicators such as construction spending, you know, stock prices, a lot of different things. So a recession has always happened when LEI's have been negative for six to eight months, which we've seen now. So you can go back here, 1973, 79, 82, 90, 2000, 2008. So, you know, it's not as bad as some of those prior recessions, but it's definitely trending

• 1:02:02Speaker 01

  negative. And we also have to worry about the debt ceiling. So, you know, the debt ceiling, the treasury is actually spending money they don't have right now. So that's going to be a big showdown all, all, all on its own. And, you know, not to get into politics, I think that it has a lot of implication on liquidity in general. So we need to watch that pretty, pretty carefully as well and how that plays out.

• 1:02:29Speaker 01

  I know we've been very US centric, but I wanted to touch really quick about Europe as well. So Europe is facing dramatic inflation right now. And that also has a big indication into

• 1:02:43Speaker 01

  global liquidity, right? Because the ECB cutting rates, et cetera, as well. German food prices year over year up almost 25%. CPI is exploding across the EU.

• 1:02:57Speaker 01

  That's really it on that. Unless you want to, we want to jump a little bit about the banking again.

• 1:03:02David Hoffman?

  Yeah, I'd like to just ask, like, man, that was, that was a bunch of like really bad indicators, man. Is, is, what's the bull case? What's, what's the case that maybe I'm just asking for a hopium, if you will. But like, well, if we take, if, what would be the counter argument to all of these like terrible indicators about the healthy of the economy? Like, is there, is there an optimistic perspective to take here?

• 1:03:30Speaker 01

  Yeah, I mean, the reality is this, this is probably some of the worst broader macro I've seen in a very long period of time. But I would say that if inflation does come down quickly because of the banking crisis, or things like that, the employment number is still holding up. So jobs is really the bright, the bright spot here. Retail sales and spending is still positive, right? So if inflation is coming down faster than expected in the next few months, and the Fed is able to pivot without spurring more inflation, and unemployment doesn't, doesn't increase, or the, the employment numbers stay relatively stable,

• 1:04:16Speaker 01

  then, then that could be saved in time. So if rates start going-

• 1:04:20David Hoffman?

  That is the needle that needs to be threaded.

• 1:04:22Speaker 01

  That is the needle needs to be threaded. That's exactly right. So, so what you saw in those, in those two cases there, where the Fed pivot bullish or bearish,

• 1:04:31Speaker 01

  you know, if the Fed pivot happens before a recession is actually starting, which could happen, right? So if, if inflation comes down fast enough, liquidity improves, et cetera. It's extremely bullish for risk assets a year forward. So the big question is- Can the economy survive without going into a recession by the time the Fed pivots? Because the Fed will eventually pivot. The question is, does the Fed pivot too late?

• 1:04:59David Hoffman?

  Right. And what you're saying with all these indicators about consumer spending and bank deposits and credit cards, all this kind of stuff is you're saying the economy is kind of running out of time?

• 1:05:10Speaker 01

  Right. I think it's more likely that the economy will fall into a recession by the time the Fed pivot. There could be, you know, sometimes even in 2008, uh, uh, seven and 2000, the market ran up into the pivot with hopium, as you mentioned, but then when reality sinks in, things deteriorate, things have sold out. So that's another, that's another possibility. But the real, the real, the real thing you have to see here is these are really the returns one year forward. And it really is about yes, recession, no recession. If you can answer that question, by the time the Fed pivots, you can make a very informed decision of what you want to do.

• 1:05:47David Hoffman?

  Okay. It kind of seems like everything hangs on that core inflation, whether that, that can start to turn over. Because if that starts to turn over, that's to me is like the foundation for everything. Is it, do you agree with that?

• 1:06:01Speaker 01

  The Fed seems to agree with you. Yeah. So that's, that's something the Fed watches for. But then another factor could be employment, right? If employment gets really, really bad, even if inflation remains high, the Fed may still react. Because they have two mandates, right? They have price stability and full employment.

• 1:06:16David Hoffman?

  Okay. Okay. What's left in this story to tell? Or have we circumnavigated it pretty well?

• 1:06:22Speaker 01

  I think we've done pretty, pretty good of a job. Just to touch about the, the banking system. You know, the banking system is still very fragile and we are likely to see regulation increase. And one of the things that I am somewhat concerned about is the so-called death of the smaller banks and more and more money going to the too big to fail. There's other implications to it that could put stress into the economy, such as commercial real estate loans and other things like that that could, that could impact the economy. So a lot of these smaller and middle sized banks do a ton of real estate loans when it comes to office space and even retail and other things.

• 1:07:06Speaker 01

  And if they fail, you could see a big credit issue hitting the economy, which again is one of the reasons I think they reacted so quickly to, to SVB. This is definitely something we're watching for as well. So again, when you think about all these things, small banks, how that plays out, consolidation, inflation, employment, and yes or no on the recession.

• 1:07:30David Hoffman?

  Right, yeah. And this is a topic of conversation that we've done before. We've had in the recent few episodes. It's been the area of focus of me personally is that the long tail of banks serve the long tail of the economy. And when the long tail of the economy starts to become underserved, that sounds like another point in the recession risk, in the economic contraction risk. And so I think we're seeing economic contraction risks left and right. You've painted a pretty clear picture of that. And then also, just the fleeting nature of some of these bullish signals that some of the market has responded to, right? And so like, my concern has been going into this conversation is like, is this bullishness, like Ether is two and

• 1:08:12David Hoffman?

  a half times off its floor, Bitcoin is two times off its floor, some risk assets and the equities markets are really strong. And my worry, my concern is that this is just a spinal reflex of banking crisis? Oh, we get the pivot. And or is this just like a short term blip of bullishness inside of a longer term contraction because the Fed, the Fed couldn't get its core CPI under control. And the decreasing inflation numbers that we've been talking about on Bankless for the last like few months or so is actually just like a return to a mean, if you will, where that base CPI, that base inflation is still very, very strong. So I think that's, I don't feel like I have a clear answer, but I don't think anyone has a clear answer as to the next few steps here.

• 1:08:56Speaker 01

  No, that's one of the reasons I said at the beginning of the call that I think the next few months are going to be some of the more interesting ones because I think a lot of these questions are going to get answered. 2022 was kind of the lead up to this. Now, clearly, the market has a very strong reaction function to liquidity. But is that Pavlovian, right? Because you ring the bell and the dogs salivate because every time anything happened like that with the Fed, things went to the moon. So everyone's salivating again. So I don't know if it's a reaction function or not. And that's exactly what I'm worried about as well.

• 1:09:31David Hoffman?

  Yeah, it certainly feels like we are at a drumroll and you can see there's somebody with the symbols, the big symbols in the background and they're ready to smash them together. We don't really know when, but we know that that's coming. Perhaps that's a way to illustrate the culmination of this episode.

• 1:09:48Speaker 01

  Exactly.

• 1:09:50David Hoffman?

  Eti, that was very, just a coherence of so many different bits of information and it's extremely impressive that you put all of this together. Just talk a little bit about your process for how, this is such a crazy semblance of data. And how do you have all of this in your brain? Like, how do you like, put this in a coherent, like, report so quickly like this?

• 1:10:12Speaker 01

  Yeah, so we actually put it as a part of our asset management team. We do this monthly. So there is a list of indicators that we track at all times. And we have a daily meeting where we basically discuss new developments in the macro and the economy, how that relates to what we're doing, our positioning, our hedging. So we hedge a lot, depending on where things look like. So we basically put all the pieces together. We followed the checklist. And when you're very versed with all the different indicators that you follow, it becomes almost like a natural thing you do.

• 1:10:46David Hoffman?

  Right. Wow. It is extremely impressive and it's extremely useful. I've learned a ton in this short time that we've had together. Eti, thank you so much for guiding through so many different parts of this economy and everything it takes to understand what's going on in macro right now.

• 1:10:59Speaker 01

  I really appreciate it.

• 1:11:01David Hoffman?

  Eti, if people want to learn more about EQUI and what you do, where should they go?

• 1:11:06Speaker 01

  EQUI.com. Simple as that.

• 1:11:08David Hoffman?

  And that is EQUI.com, correct?

• 1:11:11Speaker 01

  EQUI.com, correct.

• 1:11:13David Hoffman?

  Thank you so much, Eti. Bankless Nation, you know the deal. The next few moments are pivotable. It sounds like we're going to have Eti back on maybe in three months after those symbols come together and crash and we understand the next few steps. Maybe we'll have to ask you to come back and walk us through the next steps for this economy. But until then, Bankless Nation, you know the deal, risks and disclaimers. Ether is risky, crypto is risky. Reacting to the Fed pivot or not pivot is also risky. You can lose what you put in, but we are headed west. We are on the frontier. It's not for everyone, but we are glad you're with us on the Bankless journey. Thanks a lot.