1. Charts
2. Poor plebeians
3. Horn and Hope
4. Trading strategy
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Disclaimer: An approximate summary of the content of Arthur Hayes’s essay is presented for informational purposes only.. The opinions expressed below are the personal views of the original author. His opinions may not reflect those of the Incrypted editors.
Former head of the BitMEX cryptocurrency exchange Arthur Hayes has published a new essay – Yellen or Talkin’? The author reflects on how much the real actions of US financial regulators coincide with their speeches and what politicians are trying to achieve in the run-up to the elections.. Hayes also breaks down what geopolitical and macroeconomic factors could impact inflation in the United States and how this will ultimately impact Bitcoin and the crypto market.
The Incrypted team has prepared a short translation of the text.
US Treasury Secretary Janet Yellen and Federal Reserve Chairman Jerome Powell are oscillating between decisive action and long-winded speeches..
On November 1, 2023, the Treasury’s Quarterly Refinancing Report (QRA) included a statement to convert the majority of debt obligations to Treasury bills with a maturity of less than a year. This prompted money market funds (MMFs) to withdraw money from the reverse repurchase program (RRP) and invest in high-yield bills. This process, discussed in the essay “Bad Girl”, will provide approximately $1 trillion of liquidity to the global market.
In mid-December 2023, during the FOMC press conference, Powell said that the Fed was discussing a rate cut in 2024. The market interpreted this as “the first rate cut will take place in March”.
But which of these are real actions and which are just statements?
- Yellen switched borrowings to Treasury bills, adding hundreds of billions of dollars in liquidity. This is real money that has entered global financial markets.
- Powell and other Fed officials have talked about rate cuts and a reduction in the pace of quantitative tightening (QT) in the distant future. Without launching any real monetary stimulus.
Against this background, traditional markets (S&P 500 and Nasdaq 100) began to grow, reaching new historical highs. But Bitcoin is sounding an alarm.
After the launch of the US spot ETF, the asset fell from $48,000 to below $40,000. At the same time, the yield on two-year US Treasury bonds reached a local minimum of 4.14% in mid-January and is now moving upward.
The first explanation for the dump is the outflow of funds from Grayscale Bitcoin Trust (GBTC). But if you subtract the outflow of GBTC from the total inflow into the ETF, then as of January 22, the net gain is $820 million. Therefore, this reason seems unconvincing to me.
The second explanation, which I am going by, is that Bitcoin is waiting for the Bank Term Financing Program (BTFP) to complete.. But until 10-year Treasury rates are cut from 3% to 2%, banks participating in BTFP will not be able to survive without support.
The recovery in financial markets is giving Yellen and Powell a false sense of confidence that banks won’t go bankrupt once the politically toxic BTFP is stopped. But I think that ending the Program will cause a mini-crisis and force the Fed to cut rates, ease QT and/or start quantitative easing (QE). As I wrote in the “Pointers” essay, Bitcoin will fall until the decision on the BTFP extension is made on March 12. I didn’t expect it to happen so quickly, but I think the cryptocurrency will find a local bottom between $30,000 and $35,000. As SPX and NDX begin to fall due to the mini-crisis in March, Bitcoin will rise in anticipation of the money printer turning on and lower rates.
Now I’ll go through some charts to explain why the Fed needs a mini-crisis to stop talking and start taking action..
This is a chart of US dollar liquidity (I wrote more about this index in the essay “Teach Me, Daddy”). When the Fed launched its rate and QT hike campaign in March 2022, the index collapsed, but recovered in June 2023 due to the RRP cut.
US Dollar Liquidity Index. Data: Arthur Hayes.
The second chart is a subcomponent of the liquidity index and represents the result of changes in RRP and Treasury balance (TGA). Since the US government approved the budget in June 2023, we have received nearly $800 billion in liquidity.
Result of RRP and TGA balance changes. Data: Arthur Hayes.
At the macro level, risk assets are rising despite the Fed’s balance sheet shrinking by $1.2 trillion due to relatively high levels of dollar liquidity.
To understand why regulators need a new crisis to take action, let’s look at the chart below in detail.
S&P Regional Banking ETF (KRE) and 2-year Treasury yield. Data: Arthur Hayes.
First crisis
The chart above shows the S&P Regional Banking ETF (KRE) in white and the 2-year Treasury yield in yellow.. The main reason for the first collapse was regional banks, which do not benefit from government deposit guarantees like their TBTF counterparts.
The sharp rise in yields in the first quarter of 2023 led to an equally rapid decline in the KRE, as three large non-TBTF banks (Silvergate, Signature and Silicon Valley Bank) failed within two weeks.
Yields then fell as the market predicted the Fed would have to print money to save the system.. This was done through BTFP.
Second crisis
Everything was fine for a while, but then the market began to focus on the US budget deficit and the huge amount of bonds that needed to be issued to finance it. This problem was exacerbated by Powell’s statement at the September 2023 FOMC press conference, where he said that financial markets would do the Fed’s work by tightening monetary policy on their own..
The bond market wanted the Fed to fight inflation by continuing to raise rates.. And rates did rise, but most worryingly, long-term rates rose in a bearish manner. I detailed why this is dangerous for the financial system in the essay “The Periphery.”.
The KRE reacted by falling to levels at the height of the banking crisis, so in November Yellen switched borrowings to Treasury bills, which saved bond markets.
Hopium
The market is now predicting when RRP balances will approach zero and trying to guess what will happen next. There is a lot of talk about this, including talk about adding liquidity from the Fed. But no action has been taken yet. Two-year bond yields are rising again, and so is the KRE. Market trading on hopium.
If Yellen and Powell say the right things, the 10-year yield will fall from 3% to 2%. However, without new dollars to buy back bonds, this will not happen.. This is the discrepancy between the 2-year bond yield and the KRE. I believe that the market will be in for an unpleasant surprise when it becomes clear that Powell is all talk and no action.
The chart below shows the divergence between Bitcoin (white), 2-year Treasury yield (green) and SPX (yellow).
Bitcoin, US 2-year bond and SPX yields. Data: Arthur Hayes.
As the 2-year yield began to decline in November 2023, Bitcoin and SPX rose, but once it bottomed and reversed, Bitcoin fell and SPX continued to rise.
Bitcoin tells the world the Fed is trapped between inflation and a banking crisis. Now the regulator is trying to convince the market that banks are reliable without providing the money to make that claim a reality.
Boomers are the richest generation in the US. The top 10% of US households own ~65% of all financial assets that the Fed is pumping through money printing programs. It’s the spending of prosperous boomers that fuels the US economy.. According to Atlanta Fed estimates, GDP growth in the fourth quarter of 2023 will be 2.4%.
US Asset Allocation. Data: Arthur Hayes.
However, the rest of America is broke and drowning in debt. The richest 10% of citizens own ~65% of all financial assets and ~8% of debt. But the remaining 90% of the population has 92% of debt and only 35% of assets.
This unequal distribution of wealth and debt is a problem for politicians in a democracy, since they simultaneously need to make the rich richer and win the support of poor citizens in order to be re-elected. This is why inflation is a serious problem.
The current methodology for calculating the Consumer Price Index (CPI) is manipulation. If we go back to the 1980 or 1990 formulas, the actual inflation rate would be around 10% versus the 3% reported in the news.
Modern CPI index vs. 1980 and 1990 index. Data: Arthur Hayes.
To win the election, Joe Biden must give handouts to both rich and poor. At the macro level, the strategy is to pump up the stock market owned by the rich, thereby increasing tax revenues, and then use those revenues to pay for aid to the poor.
The richest 10% of citizens pay 74% of all income taxes, which is primarily due to capital gains tax. As a result, the US government’s finances are tied to the performance of the stock market.
US Tax Revenue Distribution. Data: Arthur Hayes.
To implement this strategy, Biden has two financial generals with different missions:
- Janet Yellen should pump up the stock market. It could do this by adjusting the pace of Treasury issuance or reducing the TGA;
- Powell must bring inflation down to acceptable levels. To do this, he can raise rates and reduce the Fed’s balance sheet.
Yellen’s job is much easier than Powell’s because there are geopolitical issues affecting inflation that the latter cannot control. It also cannot influence the size of the government budget deficit or surplus..
Post-COVID US inflation was so huge because the government was handing out stimulus to the masses, which was financed by printing money, while the rest of the world was experiencing supply issues, production shutdowns, and labor shortages.. A similar global supply chain crisis is unfolding now, but this time it is caused by El Niño and the closure of the Bab el-Mandeb Canal to Western ships.
Shipping is an old but important business. The cost per kilometer of travel by sea is cheaper than by rail, road or air transport. However, without the Panama Canal and passage through the Bab el-Mandeb Strait, ships must round Cape Horn or the Cape of Good Hope.
The onset of El Niño has caused drought in the Panama Canal, causing water levels to drop and reducing its capacity.. Elsewhere in the world, the war with Yemen’s Houthis has effectively closed the Bab al-Mandeb Strait to Western ships..
Changes in routes and delivery times due to the closure of the Bab el-Mandeb Strait. Data: Arthur Hayes.
This rerouting affects between 20% and 30% of all ship traffic and requires a significant investment of time and money. Given that inflation operates with a significant lag, if the current situation does not change, the consequences will only appear after many months.
Volume of goods passing through the Panama Canal and Bab el-Mandeb Strait. Data: Arthur Hayes.
El Niño is just beginning. Mild changes usually last between one and two years, meaning no matter how severe this cycle is, it will still be present this November. Unfortunately, Biden can’t do anything about the weather.
At the same time, the Houthis said they would attack any ship of any country that supports Israel.. They’re using $2,000 drones to attack hundreds of millions of dollars worth of merchant ships..
In fact, they are fighting an asymmetrical war, since in order to shoot down a drone costing $2,000, the United States needs to launch a missile worth $2.1 million. Even if the Houthis never hit a single target, each of their drones costs the United States 1,000 times more.
Given that the United States, as the issuer of the world’s reserve currency, is responsible for global maritime security, the whole world is watching how it handles this military challenge.
Therefore, even if Biden calls on Israel to end the war, the US will never stop financial and military aid for the Israelis for fear of losing face. The result is that the entire world gets a front-row seat to watch a future war that pits the U.S. Navy and its trillion-dollar carrier battle groups against desert men flying cheap drones.
For shipping companies to feel confident again in the Red Sea, the US Navy must shoot down every drone, as even one successful hit can cripple a commercial vessel. In addition, due to the war, shipping insurance premiums would rise sharply, reducing the profitability of voyages.
Due to weather and geopolitics, higher shipping costs could cause a spike in inflation in the third and fourth quarters of 2024, which could be exacerbated by rate cuts and a resumption of QE. Because Powell is aware of these problems, he will do everything he can to make it look like he’s cutting rates without actually cutting them.. The market has not yet appreciated this fact, but Bitcoin has.
The only thing more important than fighting inflation is the financial crisis. This is why for a rate cut, a QT winding down, and a possible QE resumption, several banks would need to go bankrupt due to the end of BTFP.
30% correction from $48,000 peak is $33,600. Therefore, I believe that Bitcoin will form support between $30,0000 and $35,000, and bought strike put options at $35,000 expiring on March 29. I also closed my positions in Solana and Bonk with a small loss.
Cryptocurrency is the last freely traded market in the world, so it will drive changes in dollar liquidity ahead of stocks and bonds. Bitcoin tells us that we need to look at actions, not words.
Yellen may add more energy to markets through new QRA, scheduled for release on January 31. If it reports the TGA being cut from $750 billion to zero, it means there is another untapped source of liquidity that will support markets. But will this be enough to prevent banks from collapsing after the BTFP?
I believe BTFP will not be renewed because neither Yellen nor Powell ever mentioned it. If this changes and the extension of the program is explicitly announced, then I will close my tracks and move to maximum levels of crypto risk while continuing to sell treasury bills and buy cryptocurrency.
But if my base case scenario comes true, as soon as Bitcoin falls below $35,000, I will start picking up from the bottom and also load up on Solana and WIF.