Original title: Sugar High
Author: Arthur Hayes, Founder of BitMEX; Translated by: Deng Tong, Golden Finance
I ended my summer vacation in the northern hemisphere by flipping the script and heading to the southern hemisphere for two weeks of skiing. I spent most of my time on backcountry skiing trips. For those who haven’t yet had the pleasure of this activity, it involves attaching skins to the bottom of your skis so you can ski up the mountain. Once you arrive at your destination, remove the skins, set your boots/skis to downhill mode, and rip into the juicy powder snow. Most of the mountains I visited were only accessible this way.
A typical four- to five-hour day consists of 80 percent uphill skiing and 20 percent downhill skiing. As a result, this activity is very energy-intensive. Your body burns calories to heat itself up to maintain homeostasis. Your legs are the largest muscle group in your body, and they are constantly working whether you're climbing a mountain or skiing downhill. My basal metabolic rate is close to 3,000 kcal; combined with the energy required to work my legs, my total daily energy intake is over 4,000 kcal.
Since it takes a lot of energy to complete this activity, the combination of foods I consume throughout the day is crucial. I eat a large breakfast in the morning that includes carbs, meat, and vegetables; what I call "real food." Breakfast fills me up, but this initial energy reserve is quickly depleted as I enter the cold forest and begin the initial climb. To keep my blood sugar levels in check, I bring snacks that I would normally avoid, like Su Zhu and Kylie Davies do to avoid liquidators appointed by the British Virgin Islands bankruptcy court. Even if I'm not hungry, I eat a Snickers bar and a candy bar every 30 minutes on average. I don't want my blood sugar levels to drop too low and disrupt my blood flow.
Eating sugary processed foods is not a long term solution to my energy needs. I also need to eat "real food". After each lap I usually stop for a few minutes, unpack my pack, and eat part of my prepared "meal". I prefer a Tupperware box filled with chicken or beef, sautéed leafy greens, and plenty of white rice.
To keep performing throughout the day, I combine periodic sugar highs with longer, cleaner bursts of “real food” fuel.
The purpose of describing my ski trip meal prep is to elicit a discussion about the relative importance of price versus quantity of money. To me, the price of money is like the Snickers and candy bars I eat for a quick glucose boost. Quantity of money is like the slow, long, burn of "real food." After Powell's wage announcement at Jackson Hole Central Jerk Circle last Friday, the Federal Reserve (Fed) finally committed to lowering its policy rate. In addition, officials from the Bank of England (BOE) and the European Central Bank (ECB) also indicated that they would continue to lower their policy rates.
Powell announced the shift around 0600 GMT, corresponding to the red oval. Risk assets such as the S&P 500 (white), gold (gold) and Bitcoin (green) all rose as currencies fell. The U.S. dollar (not shown) also closed weaker this week.
The initial positive market reaction was justified, as investors believed that assets denominated in fixed-supply fiat dollars should rise if the currency is cheaper. I agree; but… we forget that future expected rate cuts by the Fed, Bank of England, and European Central Bank will reduce the interest rate differentials between these currencies and the yen. The danger of the yen carry trade unwinding will reappear and could spoil the party unless the “real money” of central bank balance sheet expansion (i.e. printing money) increases the amount of money. (For details, please see “Arthur Hayes on the 805 crash: How will the United States and Japan respond? How to trade in the future?”)
USD/JPY rose 1.44%, while USD/JPY fell immediately after Powell's shift. This was expected, as falling USD rates would lead to a narrower USD/JPY rate differential going forward, while rising JPY rates would lead to a flat USD/JPY rate differential.
The rest of this article is intended to highlight this point and present my outlook for the critical months ahead, before an apathetic American electorate elects an “Orange Man” or a “Chameleon.”
Bull Thesis Assumptions
As we saw in August this year, a rapidly strengthening yen means a recession for global financial markets. If rate cuts in the world's three largest economies cause the yen to strengthen against their currencies, then we should expect a negative market reaction. We will have a battle between a positive force (rate cuts) and a negative force (a stronger yen). Given the tens of trillions of dollars of global financial assets financed in yen, I think there will be a negative market reaction due to a rapid unwinding of yen carry trades caused by a rapid strengthening of the yen, which will offset any benefits from a small rate cut in the dollar, pound or euro. Moreover, I think the wizards and sorcerers at the Fed, the Bank of England and the ECB realize that they must be willing to unwind and expand their balance sheets to offset the adverse effects of a stronger yen.
Consistent with my skiing analogy, the Fed is looking for the sugar rush of rate cuts before hunger sets in. From a purely economic perspective, the Fed should be raising rates, not cutting them.
The manipulated US Consumer Price Index (white) has risen 22% since 2020. The Fed’s balance sheet (gold) has increased by over $3 trillion.
The U.S. government deficit is at record levels, in part because the cost of issuing debt isn’t enough to force politicians to raise taxes or cut subsidies to balance the budget.
If the Fed really wanted to maintain confidence in the dollar, it would raise interest rates to dampen economic activity. This would make prices lower for everyone, but some people would lose their jobs. It would also discourage government borrowing because the cost of issuing debt would go up.
After the epidemic, the US economy's real GDP only experienced negative growth for two quarters. This is not a weak economy that requires a rate cut.
Even the most recent estimate of real GDP is steady at +2.0% for the third quarter of 2024. Again, this is not an economy subject to overly restrictive interest rates.
Just like I eat candy and treacle when I'm not hungry to avoid a drop in blood sugar levels, the Fed is committed to never letting financial markets stop rising. The United States is a highly financialized economy that needs fiat asset prices that only go up so that people feel rich. Stocks are flat or even down in real terms, but most people don't look at their real returns. Stocks that are rising nominally also drive capital gains tax revenue in a fiat sense. In short, falling markets are not good for the financial health of the United States. So bad girl Yellen started to subvert the Fed's rate hike cycle in September 2022. I believe that Powell, under the instructions of Yellen and the Democratic leadership, is reaping the fruits of his own labor by cutting rates when he knows he shouldn't.
I present the chart below to illustrate what happens when the US Treasury, under Yellen’s control, starts issuing large amounts of T-bills, which then suck the sterilized funds from the Fed’s reverse repurchase program (RRP) into broader financial markets.
To understand what I said in the previous paragraph, please read my article "Arthur Hayes: How much is BTC's next stop in US dollars and when will the altcoin season come".
All prices are indexed to 100 on September 30, 2022; this was the peak of RRP, which was about $2.5 trillion. RRP (green) is down 87%. The S&P 500 (gold) is up 57% in nominal fiat dollar returns. I continue to say that the US Treasury is more powerful than the Fed. The Fed has been raising the price of money until March 2023, but the Treasury has designed a way to increase the quantity of money at the same time. The result is a booming stock market in nominal terms. In real terms of gold, the oldest form of real money (everything else is credit), the S&P 500 (white) is up only 4%. In real terms of Bitcoin (the new most real hard money), the S&P 500 (magenta) is down 52%.
The US economy is not hungry for rate cuts, but Powell will provide sugar anyway. Since monetary authorities are extremely sensitive to any disturbance of nominal fiat stock price increases, Powell and Yellen will soon provide "real food" in the form of some form of Fed balance sheet expansion to offset the impact of yen strength.
Before I discuss the strength of the yen, I want to quickly touch on Powell’s ridiculous rationale for the rate cut and how it further strengthens my belief that risk asset prices are headed higher.
Powell changed his stance based on a terrible jobs report. Just days before Powell's speech at Jackson Hole, President Biden's Bureau of Labor Statistics (BLS) released a shocking negative jobs revision. They noted that the job estimate was about 800,000 too high.
Biden and his crooked economist backers have been touting the strength of the labor market during his administration. That strength puts Powell in an awkward position as senior Democratic senators like Elizabeth “Pocahontas” Warren call on him to cut rates and stimulate the economy lest the big bad Orangeman win the election. Powell is in a bind. With inflation above the Fed’s 2% target, Powell can’t cut rates based on falling inflation. Nor can Powell cut rates, citing a weak labor market.
Biden got kicked out by the Obamas for acting like an incoherent catatonic schizophrenic on prescription meds during his debate with Trump. Cameleon Harris got in office, and if you believe the mainstream media propaganda, he had nothing to do with any of the policies enacted by the Biden/Harris administration over the past four years. So the BLS can admit to its missteps without it affecting Harris, who was never actually involved in the administration she was VP of. Wow – what political Jedi magic.
Powell had been allowed to blame the poor labor market for the rate cuts, but he didn’t capitalize on that. Now that he has announced the Fed will start cutting rates in September, the only question is how big the first cut will be.
I feel more confident in my predictions when politics precede economics. This is because of Newtonian political physics - politicians in power want to stay in power. They will do whatever it takes to get re-elected, regardless of the state of the economy. This means that the incumbent Democrats will use all monetary levers to ensure the stock market rises before the November election, no matter what happens. The economy should not be short of cheap and abundant dirty fiat money.
Yen Collapse
One big factor that influences currency exchange rates is interest rate differentials and expectations of how interest rates will change in the near future.
The chart above shows the USD/JPY exchange rate (yellow) and the USD/JPY interest rate differential (white). The interest rate differential is the effective federal funds rate minus the Bank of Japan overnight deposit rate. When USD/JPY rises, the yen weakens and the dollar strengthens; when USD/JPY falls, the opposite is true. When the Fed began its tightening cycle in March 2022, the yen weakened significantly. In July of this year, the yen weakened to a peak and the interest rate differential was close to its maximum.
The yen strengthened significantly after the Bank of Japan raised its policy rate by 0.15% to 0.25% in late July. The Bank of Japan made it clear that it will start raising rates sometime in the future. The market just doesn't know when they will start raising rates in earnest. Just like unstable snowpack, you never know which snowflake or which turn on the skis will trigger an avalanche. A 0.15% reduction in the big spread should be inconsequential, but it is not. The momentum of yen appreciation has begun, and now the market is highly focused on the future direction of the USD-JPY spread. As expected, the yen strengthened after Powell's shift in stance, and the spread is expected to narrow further.
Here is the same USDJPY chart from earlier. I want to highlight again the strength of the yen after Powell confirmed that a September rate cut was a done deal.
The sugar high from the Fed rate cuts could be short-lived if traders resume unwinding USD/JPY carry trade positions as the yen appreciates. Further rate cuts to stem the decline in various financial markets would only accelerate the pace of the narrowing of the USD/JPY rate differential, which in turn would push the yen higher and cause more positions to be unwound. The market needs "real money" in the form of money printing provided by the growing Fed balance sheet to stop the bleeding.
If the yen strengthens at an accelerated pace, the first step will not be to resume QE money printing. The first step will be for the Fed to reinvest cash from maturing bonds in its portfolio into Treasuries and mortgage-backed securities. This would announce the end of its quantitative tightening (QT) program.
If the pain train continues to whine, the Fed will resort to using central bank liquidity swaps or resuming QE money printing. Behind the scenes, bad girl Yellen will increase dollar liquidity by selling more T-bills and reducing the Treasury's total account. Neither of these market manipulators will use the destabilizing effects of the unwinding of the yen carry trade as a reason to resume aggressive money printing. It is not in American nature to recognize any other country's influence on the glorious empire of liberal democracy!
If the USD/JPY exchange rate drops below 140 for any short period of time, I am sure they will not hesitate to provide the “real food” that the dirty fiat financial markets need to survive.
Favorable Factors for Crypto Trading
As we head into the final stretch of Q3, fiat liquidity conditions couldn’t be better. As crypto holders, we have the following advantages:
1 - Central banks around the world, currently led by the Federal Reserve, are lowering the price of money. The Fed is cutting interest rates while inflation is above its target and the U.S. economy continues to grow. The Bank of England and the European Central Bank are likely to continue cutting interest rates at their upcoming meetings.
2 - Bad Girl Yellen pledged to issue $271 billion in Treasury bills and conduct $30 billion in repurchases between now and the end of the year. This will add $301 billion in dollar liquidity to financial markets.
3 - The U.S. Treasury has about $740 billion left in the TGA that can and will be used to stimulate the markets and help Harris win.
4 - The Bank of Japan raised rates by 0.15% at its July 31, 2024 meeting, and then became so frightened by the pace of yen appreciation that it publicly stated that future rate hikes would take market conditions into account. This is a euphemism for "if we think the market is going to fall, we won't raise rates."
I am a crypto enthusiast and I don't do stupid things. Therefore, I don't know if stocks will go up or not. Some people point to historical instances when the Fed cuts rates and stocks fall. Some people worry that the Fed cutting rates is a leading indicator of a recession in the U.S. and even in developed markets. That may be true, but if the Fed cuts rates when inflation is above target and growth is strong, imagine what they would do if the U.S. actually had a recession. They would increase the printing presses and increase the money supply significantly. This would cause inflation, which could be bad for certain types of businesses. But for an asset like Bitcoin that has a limited supply, it would provide a trip to the moon at the speed of light!
