author | Arthur Hayes
Compile | Wu Blockchain about blockchain
Original link:
https://cryptohayes.substack.com/p/sugar-high
Any opinions expressed in this article are solely the author’s personal opinions and should not be used as the basis for investment decisions, nor should they be interpreted as advice or opinions on participating in investment transactions. They do not represent the views of Wu Blockchain.
I ended my northern hemisphere summer vacation by going the other way and heading to the southern hemisphere for two weeks of skiing. Most of the time I was doing backcountry ski mountaineering. For those who haven’t experienced this activity, it involves attaching leather to the bottom of a board that allows you to slide up the mountain. Once you reach the plateau, remove the leather, adjust the boot/board to downhill mode, and then enjoy the skiing. Most of the mountains I visited can only be reached this way.
A typical four to five-hour ski day consists of 80% uphill skiing and 20% downhill skiing. Therefore, this activity is very energy-intensive. Your body burns a lot of calories to maintain homeostasis. Your legs, the largest muscle group in the body, are constantly working whether you are climbing or skiing downhill. My basal metabolic rate is close to 3,000 kcal; when combined with the energy required to fuel my legs, my total daily expenditure is over 4,000 kcal.
Because of the incredible amount of energy required to complete this activity, it's important to eat and drink throughout the day. I start the day with a large breakfast of carbs, meat, and vegetables; I call it "real food." Breakfast fills me up, but this initial energy reserve is quickly depleted upon entering the cold woods and beginning the initial climb. To manage my blood sugar levels, I carry snacks that I would normally avoid, just like ZhuSu and Kyle do to avoid the liquidator appointed by the British Virgin Islands bankruptcy court. On average, I eat a Snickers bar or candy every 30 minutes, even if I'm not hungry. I don't want my blood sugar levels to drop and affect my performance.
Consuming sugary processed foods is not the solution for my long-term energy needs. I need to eat "real food" as well. Each time I complete a lap, I usually stop for a few minutes, open my pack, and eat my prepared "meal." I prefer a crisper filled with chicken or beef, sautéed leafy greens, and plenty of white rice.
I combine regular sugar intake with eating longer lasting, clean “real food” to sustain my performance throughout the day.
The purpose of describing my ski mountaineering diet preparation is to elicit a discussion about the relative importance of the price of money versus the quantity of money. To me, the price of money is like the Snickers and candy bars I eat for a quick glucose boost, while the quantity of money is like the slow-burning "real food." The Federal Reserve (Fed) finally committed to lowering its policy rate after Powell announced a policy shift at the Jackson Hole central bankers conference last Friday. In addition, officials from the Bank of England (BOE) and the European Central Bank (ECB) also said they would continue to cut policy rates.
Powell announced this policy shift at approximately 9:00 a.m. GMT, which corresponds to the red oval in the figure. As currencies fell, risk assets such as the S&P 500 (white), gold (yellow), and Bitcoin (green) all rose. The U.S. dollar (not shown here) also weakened this weekend.
The initial positive reaction of the market is justified as investors believe that assets denominated in fiat dollars should rise if the currency becomes cheaper. I agree with this; however… we ignore the fact that future expected rate cuts by the Fed, BoE and ECB will reduce the interest rate differentials between these currencies and the yen. The risk of a unravelling of the yen carry trade will re-emerge and could spoil the feast unless the “real food” comes in the form of central bank balance sheet expansion, i.e. money printing.
I will refer to this phenomenon frequently in this article.
USD/JPY gained 1.44%, while USD/JPY fell immediately after Powell announced the policy shift. This was expected, as the forward-looking interest rate differential between USD/JPY will narrow as USD rates fall and JPY rates remain flat or rise.
The rest of this post is intended to reinforce that point and present my key outlook for the coming months, before American voters elect either the Orange Man or the Chameleon.
As we saw in August of this year, a rapidly appreciating yen is a disaster for global financial markets. If rate cuts in the world’s three largest economies cause the yen to appreciate against their own currencies, then we should expect a negative market reaction. We are in a battle between the positive forces of rate cuts and the negative forces of a stronger yen. Given the trillions of dollars of global financial assets financed in yen, I believe that the negative market reaction from the unravelling of the yen carry trade due to a rapidly appreciating yen will far outweigh any benefits of a small rate cut in the dollar, pound or euro. Moreover, I believe that the wizards and sorcerers leading the Fed, the Bank of England and the European Central Bank recognize that they must be willing to ease policy and expand their balance sheets to counter the adverse effects of a stronger yen.
Following my skiing analogy, the Fed is preparing to enjoy the sugar rush of rate cuts before hunger sets in. From a purely economic perspective, the Fed should be raising rates at this time, not cutting them.
The US Consumer Price Index (white) has risen 22% since the beginning of 2020. The Federal Reserve's balance sheet (gold) has increased by more than $3 trillion.
The U.S. government deficit is at an all-time high in part because the cost of issuing debt has not yet risen high enough to force politicians to raise taxes or cut benefits to balance the budget.
If the Fed really wants to maintain confidence in the dollar, it should raise interest rates to dampen economic activity. This will lower prices for everyone, but some people will lose their jobs. It will also control government borrowing because the cost of issuing debt will rise.
The U.S. economy has only experienced two quarters of negative real GDP growth since the pandemic. This is not a weak economy that needs rate cuts.
Even the latest estimate for the third quarter of 2024 is a solid +2.0%. Again, this is not an economy that is suffering from too high interest rates.
Just like I eat candy and syrup when I'm not hungry to avoid a drop in my blood sugar levels, the Fed is determined to never let the financial markets stop their upward trend. The United States is a highly financialized economy that needs fiat asset prices to only go up and not down to make the people feel rich. In terms of real returns, stocks are either flat or down, but most people don't pay attention to real returns. The nominal rise in stocks denominated in fiat currencies also drives capital gains tax revenue. In short, falling markets are not good for the financial health of the American Empire. So, starting in September 2022, bad girl Yellen began to subvert the Fed's rate hike cycle. I believe that Powell, under the instructions of Yellen and Democratic leaders, is sacrificing himself and cutting rates even though he knows he shouldn't do so.
I show the chart below as an illustration of what has happened to the stock market since the U.S. Treasury, under Yellen’s control, began issuing large amounts of Treasury bills (T-bills) and pumping sterilized funds from the Fed’s reverse repurchase (RRP) program into the broader financial markets.
All prices are referenced 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 earnings in fiat dollars. I continue to state that the US Treasury is more powerful than the Fed. The Fed is raising the price of money until March 2023, but the Treasury is simultaneously driving the market up by increasing the money supply. The result is a stock market that is rising in nominally booming fiat currencies. Measured in gold, the oldest real money (everything else is credit), the S&P 500 (white) is up only 4%. Measured in Bitcoin, the newest hardest money, the S&P 500 (magenta) is down 52%.
The US economy does not need a rate cut, but Powell will provide this "sugar stimulus" anyway. Because monetary authorities are overly sensitive to anything that could disrupt the continued rise in nominal fiat stock prices, Powell and Yellen will soon provide "real food" through some form of Fed balance sheet expansion to offset the impact of yen appreciation.
Before discussing the appreciation of the yen, I want to quickly touch on the far-fetched case that Powell made for the rate cut and how this further strengthens my belief that risky asset prices will rise.
Powell's policy shift was based on a terrible jobs report. Just days before Powell's speech at Jackson Hole, US President Biden's Bureau of Labor Statistics (BLS) released a shocking negative revision to previous employment data. They noted that the previous employment estimate was overstated by about 800,000 positions.
Biden and his crooked economist backers have been touting the strength of the labor market during his tenure. This 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 to prevent the “evil orange man” from winning the election. Powell is in a bind. With inflation above the Fed’s 2% target, Powell can’t justify a rate cut by citing falling inflation. Powell also can’t justify a rate cut by citing a weak labor market. But let’s sprinkle a little political misdirection magic on this situation and see if that helps our “lower-order obedient” Powell out.
Biden was kicked out by the Obamas after he acted like a confused vegetable on prescription drugs in a debate with Trump. So in comes Chameleon Harris, who, if you believe the mainstream media propaganda, had absolutely nothing to do with any of the policies implemented by the Biden/Harris administration over the past four years. So the BLS can admit their misstep without affecting Harris, since she wasn’t actually involved in the administration she was Vice President of. Wow – what a political magic trick.
Powell could have used the weakness in the labor market to justify a rate cut, but he didn’t. Now that he has announced that the Fed will start cutting rates in September, the only question is how big the first cut will be.
I am more confident in my predictions when politics takes precedence over economics. This is because of Newtonian political physics - politicians in power want to stay in power. They will do whatever is necessary to ensure reelection regardless of economic conditions. This means that incumbent Democrats will pull all monetary levers to ensure a rising stock market before the November election, no matter what. The economy will not be short of cheap and plentiful dirty fiat money.
Yen Wrecking Ball
An important driver of exchange rates between currencies is interest rate differentials and expectations of future changes.
The above chart shows the relationship between the USD/JPY exchange rate (yellow) and the USD-JPY interest rate differential (white). The interest rate differential is the Fed Funds Effective Rate minus the Bank of Japan Overnight Deposit Rate. When the USD/JPY exchange rate rises, the yen depreciates and the dollar appreciates; when the exchange rate falls, the opposite is true. When the Fed began its rate hike cycle in March 2022, the yen depreciated sharply. In July of this year, when the interest rate differential was close to its maximum, the yen depreciation peaked.
The yen appreciated 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 would begin raising rates at some point in the future, but it was unclear to the market when they would begin in earnest. Like an unstable snow layer, you never know which flake or ski move will trigger an avalanche. While a 0.15% spread reduction should have been inconsequential, it was not. The avalanche of yen appreciation began, and the market is now highly focused on the future path of the USD-JPY spread. As expected, the yen strengthened after Powell's policy shift in anticipation of further spread reductions.
Here is the previous USD/JPY chart. I want to reiterate that the yen appreciated after Powell confirmed that the September rate cut was a done deal.
The "sugar rush" from the Fed's rate cuts could be short-lived if the yen's value surges and traders resume unwinding their USD-JPY carry trade positions. More 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 strengthen the yen and lead to more unwinding of positions. The market needs the "real food" provided by the Fed's balance sheet expansion, i.e., money printing, to stem the tide.
If the yen accelerates, the first step will not be to resume the money printing of quantitative easing (QE). The first step will be for the Fed to reinvest the cash from maturing bonds in its portfolio into US Treasuries and mortgage-backed securities. This will be declared the end of its quantitative tightening (QT) program.
If the pain train keeps going, the Fed will resort to using central bank liquidity swaps or resuming QE money printing operations. Behind the scenes, bad girl Yellen will increase dollar liquidity by selling more T-bills and draining the Treasury General Account (TGA). None of these market manipulators will use the devastating impact of the unravelling of the yen carry trade as a reason to resume aggressive money printing. The US is extremely reluctant to admit any other country to have any influence on this glorious empire of freedom and democracy!
If USDJPY falls below 140 quickly, I believe they will not hesitate to provide the "real food" that the dirty fiat financial markets feed on.
Trading Setup
As we head into the final stretch of Q3, fiat liquidity conditions could not be more favorable for crypto holders:
Central banks around the world are making money cheaper, led by the Federal Reserve, which is cutting rates despite above-target inflation and continued growth in the U.S. The Bank of England (BOE) and the European Central Bank (ECB) are likely to continue cutting rates at their upcoming meetings.
Bad girl Yellen promised to issue $271 billion in Treasury bills (T-bills) and conduct $30 billion in repurchases by the end of this year. This will add $301 billion in U.S. dollar liquidity to the financial market.
The U.S. Treasury has about $740 billion left in the Treasury General Account (TGA), which can and will be used to boost the markets and help Harris win.
The Bank of Japan was so frightened by the pace of the yen’s appreciation that it publicly stated that future rate hikes would take market conditions into account after raising rates by 0.15% at its July 31, 2024 meeting. This is a euphemism for “if we think the market is going to go down, we won’t raise rates.”
I am a cryptocurrency enthusiast and do not dabble in the stock market. Therefore, I do not know if stocks will go up or not. Some people point to historical instances where the stock market has fallen when the Fed cuts rates. Some worry that a Fed rate cut is a precursor to a recession in the U.S. and even in developed markets. This may be true, but if the Fed cuts rates when inflation is above target and growth is strong, imagine what they would do if a recession actually hit the U.S. They would rev up the printing presses, dramatically increasing the money supply. This would lead to inflation, which could be bad for certain types of businesses. But for a finite supply asset like Bitcoin, it would provide an opportunity to fly to the moon at the speed of light!
