Don't Fight The Fed
Friday July 22, 2022 - Issue # 17
“Don’t fight the Fed” was the motto at the start of, and throughout this past raging bull market as central banks all over the world tried to hamper the economic blowback of a global pandemic. And now? Well, it’s been a pretty brutal wake up call to those (including myself) that expected the same central banks to print their way into oblivion instead of taking their (or, one of their) last chance(s) to kick the can down the road, again.
How many times have you heard the name Paul Volcker this year? Too many times for my liking. It seems that the world of finance is split between those that are drinking the Kool Aid — the Fed is going reel inflation back to their 2% target by putting the pedal to the metal on interest rates — and those that aren’t falling for the same ol’ tricks and believe that the Fed is posturing before they reverse course back to easy money.
The big difference between then and now is that debt to GDP in the late 70’s was ~32% versus ~130% in 2022.
In economics, the debt-to-GDP ratio is the ratio between a country's government debt (measured in units of currency) and its gross domestic product (GDP) (measured in units of currency per year). A low debt-to-GDP ratio indicates an economy that produces and sells goods and services is sufficient to pay back debts without incurring further debt.
I mean, I think that debt-to-GDP definition is pretty self-explanatory…the central bank of the world’s reserve currency is in between a rock and a hard place — keep the money printers hot and keep federal fund rates low, or default. It’s the privileged position you might find yourself in if you have grey hair, are in charge of the world’s most important monetary regime, and are just trying to keep your pockets fat and your friends happy so that you can maintain your status until you pass your burden to the next incumbent, just as you were passed the gnarly baton once before.
Woah, I just realized I haven’t mentioned bitcoin or crypto once, yet.
Bitcoin and the broader crypto market took off and went on a massive “up only” run during the last bout of QE (quantitative easing). Then, it retracted sharply and just as aggressively when the Fed decided to flip the switch, hit the breaks, and do a 180 like they were trying to shake the cops on a wild chase. Liquidity was drained from the system and risk-off was the new sentiment. Continuous rate hikes and extreme hawkishness from the Fed regarding their attack on inflation had the markets quickly changing their position about cash being trash and sent the USD flying versus pretty much everything else.
A “soft landing” to the Fed at this point means getting away from this all with some level of credibility intact.
It could be something like: Okay, we did what we needed to do to combat the pandemic; we didn’t anticipate the Russian invasion of Ukraine which exacerbated inflationary effects on fuel and food; our allies (EU & Japan) are in dire straights, and we see a recession on the horizon — we are going to take a pause on rate decisions until the next set of data comes in.
“Don’t fight the Fed” has been an adage that has been around for decades; “it’s all one trade” has been around for a while now as well — neither of those have been more true then they are today and they both speak to the same backdrop: central bank actions in the current monetary regime have such an overwhelmingly powerful impact on all asset prices that everything else is pretty much just an afterthought.
The cat is out of the bag…investors across the board believe that when the Fed eases up, it’s time to pile in and I think there’s a pretty wide consensus that Bitcoin and the broader crypto market will bounce the hardest. In the last crypto bear market over 2018 and 2019, no one really knew what to expect from Bitcoin and other cryptos which meant a long, long winter. This time around, investors have a good idea where Bitcoin and subsequently, the broader crypto market stands: it loves QE and it’s detests QT (quantitative tightening).
I think that means we chop around until something in the financial markets break, and the Fed is forced to react. From there, it’s likely we’re back to risk-on.
Tune in next week — it should be a spicy one off the back of Wednesday’s FOMC meeting where the Fed is likely to raise rates by 75 bps with an outside shot of a 100 bps hike.