Original title: Boom Times... Delayed
Author: Arthur Hayes, Founder of BitMEX; Translated by: Deng Tong, Golden Finance
Like Pavlov’s dogs, we all think the correct response to rate cuts is BTFD. This behavioral response is rooted in recent memories of low peacetime inflation under the US. Whenever there is a threat of deflation, which is scary for holders of financial assets (aka the rich), the Federal Reserve (Fed) responds forcefully by pressing the Brrr button on the printing presses. The US dollar is the global reserve currency, creating easy monetary conditions for the world.
The effect of global fiscal policy to combat the pandemic has ended the era of deflation and ushered in an era of inflation. Central banks have belatedly acknowledged the inflationary impact of COVID-19, defended monetary and fiscal policies, and raised interest rates. Global bond markets, most importantly the U.S. bond market, believe that our monetary masters are serious about defeating inflation. However, the assumption is that central bankers will continue to increase the price of money and reduce the money supply to appease the bond markets. This is a very questionable assumption given the current political climate.
I will focus on the U.S. Treasury market because it is the most critical debt market in the world due to the U.S. dollar’s role as the global reserve currency. All other debt instruments react in some way to Treasury yields, regardless of the currency in which they are issued. Bond yields incorporate market expectations for growth and inflation. The Goldilocks economic scenario is growth with little inflation. The Big Bad Wolf economic scenario is growth with very high inflation.
The Fed has convinced the Treasury market that it is serious about fighting inflation by raising its policy rate at the fastest pace since the early 1980s. From March 2022 to July 2023, the Fed raised rates by at least 0.25% at every meeting. During this period, the 10-year Treasury yield never exceeded 4%, even as the government-manipulated inflation index hit a 40-year high. The market is satisfied that the Fed will continue to raise rates to eliminate inflation, so long-term yields will not converge gradually.
US Consumer Price Index (white), 10-year US Treasury yield (gold), Fed Funds Cap (green)
That all changed at the Jackson Hole Central Bastard Conference in August 2023. Powell said the Fed would pause on rate hikes at its upcoming September meeting. But the specter of inflation still haunts the market. This is mainly because inflation is driven primarily by increased government spending and shows no signs of abating.
MIT economists found that government spending is the main culprit for inflation.
On the one hand, politicians know that high inflation reduces their chances of reelection. But on the other hand, offering free stuff to voters through currency devaluation increases their chances of reelection. If you only give out goodies to your inner circle, but the payer of these goodies is the larger of the hard-earned savings of your opponents and your supporters, then the political calculation favors more government spending. As a result, you will never be voted out of office. This is exactly the policy pursued by the administration of US President Biden.
Total government spending is at its highest level ever in peacetime. Of course, I use the word "peaceful" relatively, with an eye only to the feelings of the citizens of the Empire; the past few years can hardly be described as peaceful for the poor souls who have died and continue to die because American-made weapons have fallen into the hands of those who advance democracy.
If taxes were raised to pay for the generous spending, then the spending wouldn't be a problem. However, raising taxes is a very unpopular thing for current politicians. Therefore, it's not happening.
Against this fiscal backdrop, Fed Chairman Powell hinted at the Jackson Hole conference on August 23, 2023 that they will pause rate hikes at the upcoming September meeting. The more the Fed raises rates, the more it costs the government to finance the deficit. The Fed can put a stop to this wanton spending by making it more expensive to finance the deficit. Spending is the main driver of the Fed's attempts to quell inflation, but it refuses to continue raising rates to succeed. Therefore, the market will have its work cut out for the Fed.
After the speech, the 10-year Treasury yield began to rise rapidly from about 4.4% to 5%. This was quite astonishing considering that even with inflation at 9% in 2022, the 10-year yield was only hovering around 2%; 18 months later, after inflation had fallen to about 3%, the 10-year yield was heading for 5%. The rise in rates led to a 10% correction in the stock market and, more importantly, revived concerns that regional banks in the United States would fail again due to losses on their Treasury portfolios. Faced with rising costs to finance the government deficit, reduced capital gains tax revenue due to falling stock markets, and a potential banking crisis, bad girl Yellen stepped in to provide dollar liquidity and end the rout.
As I wrote in my article “Bad Girls”, Yellen gave forward guidance that the US Treasury would issue more T-bills. The net effect of this was to take money out of the Fed’s Reverse Repo Program (RRP) and put it into T-bills, which could be re-used throughout the financial system. This announcement was made on November 1, 2024, kicking off a bull market in stocks, bonds, and most importantly, cryptocurrencies.
From the end of August to the end of October 2023, Bitcoin fluctuated, but after Yellen injected liquidity, Bitcoin began to take off and hit an all-time high in March this year.
What will be the future market trend of BTC?
History never repeats itself, but it always rhymes. I didn’t realize this in my last article, Sugar High, where I talked about the impact of Powell’s salary adjustment. I was a little uneasy because I had a consistent view on the positive impact of the upcoming rate cut on risk markets. On the way to Seoul, I happened to take a look at my Bloomberg Watchlist, where I track the daily changes in RRP. I noticed that it was higher than the last time I checked, which was puzzling because I expected it to continue to fall because the U.S. Treasury issued net Treasury bills (T-bills). I dug deeper and found that the rise began on August 23, the day Powell adjusted his salary policy. Next, I considered whether the surge in RRP could be explained by window dressing. Financial institutions often lie about the state of their balance sheets at the end of the quarter. Regarding RRP, financial institutions usually deposit funds into the facility at the end of the quarter and withdraw them the following week. The third quarter ends Sept. 30, so window dressing doesn’t explain the surge.
Then I wondered, would money market funds (MMFs) sell T-bills in search of the highest and safest short-term USD yields and park cash in RRPs as T-bill yields fell? I plotted a chart below of 1-month (white), 3-month (yellow) and 6-month (green) T-bills. The vertical lines mark the following dates: Red Line - when the BoJ raised rates, Blue Line - when the BoJ capitulated and announced that it would not consider future rate hikes if they thought the market was not reacting well, Purple Line - the day of the Jackson Hole speech.
Money market fund managers must decide how to get the most return from new deposits and maturing T-bills. The RRP yield is 5.3% and if the yield is slightly higher, the funds will be invested in T-bills. Starting in mid-July, the 3-month and 6-month T-bill yields fell below the RRP yield. However, this was mainly due to market expectations of significant Fed easing as the strong yen triggered the unwinding of carry trades. The 1-month T-bill yield is still slightly higher than the RRP yield, which makes sense because the Fed has not yet given forward guidance on a September rate cut. To confirm my guess, I plotted a chart of the RRP balances.
RRP balances generally declined until August 23, when Powell gave a speech at Jackson Hole, announcing the September rate cut (indicated by the vertical white line in the chart above). The Fed will meet on September 18, and the Federal Funds rate will be lowered by at least 5.00% to 5.25%. This confirms the expected trend of the 3-month and 6-month Treasury bills, with the 1-month Treasury bill yield starting to close the gap. RRP yields only fall the day after a rate cut. Therefore, between now and September 18, this instrument offers the highest yield among all suitable yield instruments. Predictably, RRP balances began to rise immediately after Powell's speech as money market fund managers maximize current and future interest income.
While Bitcoin initially surged to $64,000 on the day of Powell's salary announcement, it has given back 10% of its fiat dollar price over the past week. I believe Bitcoin is the most sensitive tool to track USD fiat liquidity conditions. Once RRP starts to rise to around $120 billion, Bitcoin will plummet. Rising RRP eliminates currencies as they sit inert on the Fed's balance sheet and cannot be re-used in the global financial system.
Bitcoin is extremely volatile, so I accept the criticism that I may have read too much into one week's price action. But my interpretation of events fits the observed price action well enough to be explained away by random noise. Testing my theory is easy. Assuming the Fed does not cut rates before the September meeting, I expect Treasury yields to remain firmly below the RRP. Therefore, the RRP should continue to rise, with Bitcoin trading around these levels at best and a slow decline to $50,000 at worst. Let's see how that plays out.
My shift in perspective has my hand hovering over the buy button. I am not selling cryptocurrencies because I am short-term bearish. As I will explain, my pessimism is temporary.
Out-of-control deficit
The Fed has done nothing to control the most important factor in inflation: government spending. Governments reduce spending or increase taxes only when they can no longer afford to finance their deficits. The Fed’s so-called restrictive policies are just lip service, and its independence is a cute story taught to gullible economist followers.
If the Fed doesn’t tighten conditions, the bond market will tighten. Just as the 10-year Treasury yield unexpectedly rose after the Fed paused in 2023, a Fed rate cut in 2024 will spur yields toward a dangerous 5%.
Why are 10-year Treasury bonds yielding 5% so dangerous to the health of the financial system under our rule? To answer that question, it’s because that’s the level at which bad girl Yellen felt it necessary to step in and inject liquidity last year. She knows better than I do how broken the banking system is as bond yields rise; based on her actions, I can only guess at the extent of the problem.
Like a dog, she has conditioned me to expect a response when prodded by something. A 5% 10-year Treasury yield would prevent the bull market from developing strongly. It would also rekindle concerns about the health of the balance sheets of banks that are not “too big to fail.” Mortgage rates would rise, reducing housing affordability, a big issue for American voters this election cycle. All of this could come to pass before the Fed cuts rates. Given these circumstances and Yellen’s unwavering loyalty to Democratic Manchurian candidate Kamala Harris, these red bottoms will sweep across the “free” market.
Apparently, bad girl Yellen will not stop until she has done everything possible to ensure Kamala Harris is elected President of the United States. First, she will begin to reduce the Treasury General Account (TGA). Yellen may even provide forward guidance on her desire to exhaust the TGA so that the market will quickly react as she wishes... with more force! Then, she will instruct Powell to stop quantitative tightening (QT) and possibly restart quantitative easing (QE). All of these monetary policies are bullish for risk assets, especially Bitcoin. Assuming the Fed continues to cut interest rates, the size of the money supply injections must be large enough to offset the rising RRP.
Yellen must act fast or the situation could turn into a full-blown voter confidence crisis in the US economy. This would spell Harris’ death at the ballot box… unless by some miracle some mail-in ballots are found. As Stalin might have said, “It’s not the people who vote that count; it’s the people who count the votes.” I kid… I kid ;).
If this happens, I expect intervention to begin in late September. Between now and then, Bitcoin will at best continue to fall, while altcoins will likely fall deeper into the trough.
I had publicly said the bull run would resume in September. I changed my mind, but it does not affect my positioning in any way. I am still long in an unleveraged manner. The only additions to my portfolio are increasing position sizes in solid shitcoin projects that are trading at increasing discounts below my perception of fair value. Once fiat liquidity taps increase predictably, the tokens of projects whose users pay real money to use their products will surge.
For those professional traders with monthly PNL targets or weekend warriors using leverage, soz, my short term market predictions are no better than selling crypto. I have a long term bias that the idiots running the system will resort to printing money to solve all problems. I write these articles to put current financial and political events in context and see if my long term assumptions are still valid. But I promise that one day my short term predictions will be more accurate... maybe... I hope ;).
