🥛 Rate hike odds just got hit 📉

GM. This is Milk Road, the daily newsletter that's the friend who texts you before the news breaks.

Here’s what we’ve got for you today:

✍️ Rate hike odds just got hit.
🎙️ The Milk Road Show: Matt Hougan: Crypto Is Down 50%… Wall Street Is ALL-IN.
🍪 Scott Melker: Optimists always win with time.

Prices as of 2:00 p.m. ET. Powered by CoinGecko.

THE FED JUST GOT AN EXCUSE NOT TO HIKE 💪

Interest rates are the reason we pay attention to inflation reports around here.

When rates come down → borrowing gets cheaper → households and businesses take out more loans → more money moves through the economy → and some of that money ends up in risk assets (like crypto).

When rates go up, the whole sequence runs in reverse.

The Federal Reserve has now held its rate at 3.50% to 3.75% for five meetings in a row. And at the last one, on July 29, three of its members voted to push rates higher.

Good news is, yesterday's inflation report from the Bureau of Labor Statistics made that argument a lot harder for those dissenting voices to win.

Prices across the full basket of goods and services rose 3.4% over the past year, still well above the Fed's 2% target. But energy is doing most of that work, up 14.7% over twelve months, with gasoline up 24.6%.

That is a supply problem: Brent crude (the global oil benchmark) is still ~$83 a barrel while the standoff over the Strait of Hormuz drags on.

Raising interest rates does not produce more oil/lower energy prices.

What the Fed has more influence over is core inflation, which is the same basket of goods, with food and energy taken out. Those two swing on weather and war rather than on how much money is moving around.

Core prices rose 0.2% in July and 2.5% over the past year. That is the slowest pace since March 2021.

And on top of that, year-over-year wholesale inflation (PPI) came in at 4.7% this morning, below the 4.9% that was expected.

Point being: when it comes to rising inflation, energy is doing almost all of the work right now. 👇

Source: BLS

So why’s the part the Fed can influence actually behaving itself? Because almost nobody is getting a raise.

Check out the second-quarter productivity figures:

Output: up 2.5% from a year earlier.
Hours worked: up 0.2%.
Unit labor costs (what a company pays in wages to produce one more unit of stuff): up 1.4% over four quarters.
Labor's share of output (the slice of everything the economy produces that gets paid out as wages): 52.9%, the lowest since records began in 1947.

Point being: companies are producing more without paying more to produce it.

There is no spiral of rising wages feeding rising prices for the Fed to break.

But if all that extra output isn't going into paychecks… where is it going?

All that extra output is going into profits.

Companies in the S&P 500 are tracking 32% earnings growth for the second quarter once you set Alphabet and Amazon aside. (Both booked one-off accounting gains that flatter the overall figure.)

That’s the seventh quarter in a row of double-digit growth.

Spending held up too. Economists track a measure called real final sales to private domestic purchasers: consumer spending plus business investment, with the noisier trade and inventory swings removed.

It grew 3.9% in the second quarter, up from 1.7% in the first.

Source: BLS

That’s what it looks like when companies buy machines and software instead of hiring people.

And it comes with a cost.

Employers cut 23,000 jobs in July against expectations of 95,000 added, the first monthly loss since the pandemic recovery. Adjusted for inflation, hourly pay is slightly lower than a year ago.

And the sequence the market has been worried about since July goes like this:

Oil rises → inflation stays high → bond yields stay high → the Fed holds or raises rates.

Yesterday's numbers do nothing about oil, but they do weaken the middle part of that sequence.

Traders on Polymarket now put the odds of a rate rise in September at 33%, with no change at 67%. Two weeks ago, a rise was the more likely of the two.

Source: Polymarket

The Milk Road Macro Index, our internal gauge of whether conditions favor taking risk, flipped to risk-on last week.

Two more data points land before the Fed meets on September 15: August inflation on the 11th, and the August jobs report.

If core inflation keeps easing while energy pressure fades, the rate rise comes off the table and cuts become more palatable for the Fed.

That’s the condition crypto has been waiting for all year.

Btw - if you want to see what our analysts are buying ahead of that, you can try Milk Road PRO for a buck for 7 days.

BITE-SIZED COOKIES FOR THE ROAD 🍪

Worried about your privacy onchain? Midnight is a blockchain designed to protect sensitive data.*

Scott Melker: Optimists always win with time. "If you want to be a bear, you have to have exceptional timing and you're only going to be right for a little while."

Matthew Sigel: BTC miners are expert at sourcing cheap electricity via land purchases, which became much more valuable as the Frontier AI Labs began to crop up.

Novogratz: AI isn't going to kill jobs, but the transition is going to be brutal, and a whole bunch of new ideas are about to be thrown around because of it.

*this is sponsored content.