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Happy news on inflation

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Good morning. We thought the market would explode upwards after the cool US consumer price index numbers came out. But the S&P closed up less than 1 per cent. Is a soft landing totally baked into prices? Let us know what you think: robert.armstrong@ft.com and ethan.wu@ft.com.

From slow grind to easy glide

The first thing to say about yesterday’s inflation data release is that it was good. Inflation is too high and we’re happy it’s falling. The second is that we got this report wrong. We (and most forecasters) didn’t anticipate several disinflationary surprises tucked into yesterday’s CPI numbers. The third is that the hard part — for the Fed, the economy and markets — is still to come.

The data themselves showed a broad-based deceleration in inflation, with month-on-month core CPI sinking below 0.2 per cent (or 2.4 per cent annualised). Core goods prices fell 0.5 per cent, reflecting overbuilt retailer inventories and normalisation in the new and used car markets. Cheaper energy also helped the headline number. The happy trend is clear:

A few quirks flattered the numbers. Airfares, a volatile component that has fuelled transportation services inflation since the coronavirus pandemic, plunged, but could easily rebound next month. Hotel prices, another noisy bit we discussed last month after they implausibly soared, fell back to earth, dragging monthly shelter inflation down to 0.6 per cent from 0.8 per cent. On the central housing inflation components, however, November doesn’t look soft at all (chart by Carl Riccadonna of BNP Paribas):

Rent and OER inflation chart

These are quibbles, though. Overall, the good news swamped the bad, leaving us a bit less sure of our “slow grind down” view of inflation. Our argument hinged on CPI shelter inflation taking a while to roll over and transportation services remaining volatile. Both could still prove true, but the offsetting drags on inflation look stronger than we thought. (Of course, two data points don’t make a trend and we’ll need to see what the coming months hold.)

What will the Fed, which meets today, make of yesterday’s data? Remember Jay Powell’s three-pronged inflation framework, in which he specified the conditions for the Fed to back off. Here’s a progress report:

  1. Core goods prices need to keep falling. This is happening.

  2. CPI and personal consumption expenditures housing inflation need to follow private rent indices down. Too early to tell.

  3. Ex-housing core services inflation needs to fall decisively. This is starting to happen! Excluding rents, core services inflation rose just 0.1 per cent in November, calculates Omair Sharif, CPI guru at Inflation Insights.

On the last point, Powell claims ex-housing core services inflation is linked to wages. November’s numbers make a hash of that idea. Besides shelter, very strong wage growth is not showing up in many services prices, making it hard to know how seriously to take Powell’s schema. Someone please ask him about this at today’s presser.

Zooming out, a gentler inflation number probably makes recession less likely, but only a little. The Fed is rightly afraid of letting up too early and inflation rebounding. It will press on, though perhaps more slowly. And as we’ve written, the biggest trouble will come when inflation is falling, but still elevated, while activity data are deteriorating. How the central bank balances its dual mandate at the moment will be crucial. Yesterday’s inflation numbers suggest we are approaching that decisive point more quickly, and in better shape, than expected. They don’t suggest we’ll avoid it. (Ethan Wu)

The SBF allegations

Before reading the civil and criminal complaints against Sam Bankman-Fried, my view was that large financial frauds and scandals develop incrementally. Someone pushes some ethical, prudential or legal limit a bit. That smallish violation is so successful that it is repeated, or it requires more nasty/dangerous/illegal activity to cover it up. A spiral follows. I think of both the Enron accounting fraud and the Wells Fargo fake accounts scandal this way, for example.

Things go to hell by baby steps, in other words. But if the allegations from SEC, DOJ and CFTC are true, this is not what happened at FTX. FTX was hell from the word go.

From the SEC’s complaint:

From the start of FTX’s operations in or around May 2019 until at least 2021, FTX customers deposited fiat currency (eg, US Dollars) into bank accounts controlled by [FTX’s affiliated hedge fund] Alameda

. . . Alameda did not segregate these customer funds, but instead commingled them with its other assets, and used them indiscriminately 

And:

Alameda was able to maintain a negative balance in its customer account at FTX . . . No other customer account at FTX was permitted to maintain a negative balance

And:

. . . In or around May 2022, as prices of crypto assets were dropping precipitously, several . . . lenders demanded re-payment from Alameda. Because Alameda did not have sufficient assets to cover all of these obligations, Bankman-Fried directed Alameda to draw on its “line of credit” from FTX. Billions of dollars of FTX customer funds were thus diverted to Alameda

FTX did not tell its investors or customers that this was how things worked. On the contrary:

FTX’s Terms of Service . . . assured FTX customers that their assets were secure, providing: “you control the Digital Assets held in your Account;” “[t]itle to your Digital Assets shall at all times remain with you and shall not transfer to FTX;” and “none of the digital assets in your account are the property of, or shall or may be loaned to, FTX Trading” . . . FTX represented that it “segregates customer assets from its own assets across our platforms.” 

From the start — according to the allegations — when you put money in your FTX exchange trading account, it went straight to the bank account of a hedge fund that did whatever it liked with it. That hedge fund, meanwhile, could accumulate unlimited losses at your expense, doing whatever. You were told none of this was allowed to happen.

No increments here. The whole set-up was ludicrously unsustainable and utterly dishonest on the day Bankman-Fried and his partners first hung out their shingle.

The SEC complaint focuses not on the FTX customers who can’t get their money back, but the venture investors who provided equity capital. Joseph Hall, a partner at the law firm Davis Polk and an expert on both securities and crypto, says the SEC case is “a garden variety securities fraud complaint” and not about crypto per se. “It’s about a capital-raising transaction that defrauded investors, a tale as old as time.”

But the same basic allegation — that Bankman-Fried and FTX told investors that their money was segregated and then used it to engage in their own wildly risky speculation — turns into allegations of wire fraud, commodities fraud, money laundering and campaign finance violations in the DOJ indictment, when a few additional facts, transactions, transfers and donations are added in. In the CFTC complaint, the same rotten set-up becomes a violation of the commodities exchange act.

What to make of all this? Three points come to mind:

  1. The allegations are so insane that they make me wonder if Bankman-Fried and his lieutenants are quite all there. This is absolutely not to say they should not be held fully accountable under the law, if the charges are proven. It is important that this happens. But a pure criminal mind would not create an organisation as shambolic as the one described in the complaints. It may well be true that “this is just plain old embezzlement”, as John Ray, FTX’s new, court-appointed chief executive, said yesterday. Yet the whole thing also stinks of pathological narcissism, self-delusion and cultishness.

  2. This makes the complaints an even more withering charge sheet against the investment funds that put customer or corporate money into FTX. If the allegations are true, can we avoid the conclusion that (for example) Sequoia Capital, the Ontario Teachers’ Pension Plan and Tiger Global are a bunch of clowns?

  3. All that said, I still think the SEC should not treat cryptocurrencies as securities, or create a special regulatory apparatus for dealing with them. This gives crypto too much credit. They are more like baseball cards, tulip bulbs or sports bets than investment products. The SEC can of course come after crypto companies for lying to investors, as they have with FTX. But they should not treat cryptocurrency buyers as investors. That gives cryptocurrencies too much credit. (Hall of Davis Polk embraced my baseball analogy, by the way, but thinks it points the other way. “If people take all their retirement savings and start trading Topps baseball cards, maybe the government should step in and say ‘let’s make sure the market for baseball cards is fair’. Your objective view of the asset class is not the issue.” Agree to disagree.)

One good read

Howard Marks on markets’ sea change.

Cryptofinance — Scott Chipolina filters out the noise of the global cryptocurrency industry. Sign up here

Swamp Notes — Expert insight on the intersection of money and power in US politics. Sign up here

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