Original title: Yellen or Talkin?

Original author: Arthur Hayes

Original compilation: Mary Liu, BitpushNews

U.S. Treasury Secretary Janet Yellen and dim-witted Federal Reserve Chairman Jerome Powell have vacillated between decisive action and equivocation. Its best not to fight them when they act, but be careful when they are just shouting slogans, as many market signals can mislead you into a path destined to lose money.

On November 1, 2023, the U.S. Treasury Department’s Quarterly Refinancing Announcement (QRA) included a statement that Janet Yellen would shift most borrowings to short-term Treasury bills (T-bills) with maturities of less than one year . This prompted money market funds (MMFs) to withdraw funds from the Feds reverse repurchase program (RRP) and invest in higher-yielding Treasury bonds. The results, detailed in my article Bad Gurl, were and are providing liquidity injections that, once completed, would total close to $1 trillion.

In mid-December 2023, at the FOMC press conference, Powell announced that they were discussing a rate cut in 2024. Thats a dramatic reversal from his comments two weeks ago, when he assured markets the Fed would keep tightening to ensure inflation didnt return. The market believes that this means that the Federal Reserves first interest rate cut in this cycle of interest rate hikes will occur in March this year. Then, earlier this month, Dallas Fed President Logan threw out a smoke bomb that the pace of quantitative tightening (QT) would gradually slow down as the RRP balance approaches zero. The reason is that the Fed does not want any problems with dollar liquidity when it stops printing money.

Let’s review what is talk and what is actual action. Yellen converted department borrowings into Treasury debt, adding hundreds of billions of dollars in liquidity so far. This is the actual flow of money into global financial markets. Powell and other Fed governors talked about a big game about cutting interest rates and tapering the pace of quantitative easing in the distant future. The talk did not add any monetary stimulus. However, the market viewed actions and words as the same thing and rallied after November 1 and continued to rise throughout the month.

The markets Im referring to are the SP 500 and the Nasdaq 100, both of which have hit all-time highs. But all was not well.

A real alarm in the direction of USD liquidity – Bitcoin – is sending out warning signs. Following the launch of the US spot ETF, Bitcoin has fallen from a high of $48,000 to below $40,000. In line with Bitcoin’s local highs, the 2-year US Treasury yield hit a local low of 4.14% in mid-January and is currently rising.

The first argument for Bitcoins recent plunge is the outflows from the Grayscale Bitcoin Trust (GBTC), which doesnt hold up because when you net the outflows from GBTC with the inflows from the newly listed spot Bitcoin ETF When calculated, the result is that as of January 22, the net inflow was $820 billion.

The second argument, and this is my position, is that the Bitcoin market expects the Bank Term Funding Program (BTFP) to be suspended.

This event will not have a positive impact because the Fed has not yet lowered interest rates to a level that would push the 10-year Treasury bond rate into the 2% to 3% range. At these levels, the bond portfolios of non-too-big-to-fail (TBTF) banks have returned to profitability, while there are currently large unrealized losses on their balance sheets. Until interest rates are reduced to the levels mentioned above, these banks cannot survive without the support provided by the government through the BTFP. The exuberance in financial markets gave Yellen and Powell a false confidence that the market would not let some non-TBTF banks fail once the BTFP was suspended. Therefore, they believe that the politically toxic BTFP can be stopped and there will be no negative market reaction. However, I think the opposite is true: the cessation of BTFP will trigger a mini-financial crisis and force the Fed to stop talking and allow Yellen to start cutting interest rates, tapering QT, or resuming money-printing easing (QE) through quantitative means. Bitcoin’s price action tells me I’m right and they’re wrong.

The Fed would rather stimulate the market with speeches and Wall Street Journal columns because they are so fearful of inflation. The belligerent puppets who presided over the pacifist foreign policy of the United States are now locked in another Middle East war and a never-ending battle with the Houthis in Yemen. Later in this article, I will elaborate on why this war is important and could lead to a disturbing spike in commodity inflation in the run-up to the US election this November.

Contrary to what mainstream Western financial media tells you, inflation remains a problem for most bankrupt Americans. Voters decide presidents based on the economy, and now US President Joe Biden and his fellow Democrats are destined to be defeated by red-necked Representative Trump and the Republicans.

As I wrote in the Signposts article, I believe that Bitcoin will fall before the BTFP update plan is decided on March 12. I didnt expect it to happen so soon, but I think Bitcoin will find a local bottom between $30,000 and $35,000.

As the SPX and NDX fall due to the mini-financial crisis in March, Bitcoin will rise as it will represent the Fed finally turning its talk of cutting rates and printing money into action by pressing the Brrrr button.

Now, Im going to quickly give readers some insight into why I think the Fed needs a mini-financial crisis to stop the talk.

This is the USD liquidity chart. The index plummeted as the Federal Reserve began raising interest rates and quantitative easing in March 2022. However, as suggested retail prices have fallen since June 2023, the index is back to its lowest level since April 2022.

This chart is a subcomponent of the index, net of changes in RRP and TGA balances. Since the U.S. government passed its budget in June 2023, nearly $800 billion in new liquidity has been added.

From a macro level, although the Feds balance sheet has been reduced by US$1.2 trillion, risky assets are still pouring in due to the relatively high level of US dollar liquidity.

first crisis

If we dig deeper into the non-TBTF bank failures, we see that Yellen and Powell were forced to take action to bail out the U.S. banking industry. The chart above is the SP Regional Bank ETF (KRE) in white versus the 2-year Treasury yield in yellow. The banks in the index are small and medium-sized banks that do not enjoy government deposit guarantees like the better-known and more profitable TBTF family. Yields rose sharply in the first quarter of 2023, causing KRE to plummet and three major non-TBTF banks (Silvergate, Signature, and Silicon Valley Bank) to go bankrupt within two weeks. Yields plummeted as the market knew the Fed would have to print money through BTFP to save the system.

second crisis

All was well for a time, but markets began to focus on the out-of-control U.S. deficit and the huge amount of debt that would have to be issued to finance it. The issue was further complicated by Powells statement at the September 2023 Federal Open Market Committee (FOMC) press conference, in which he said financial markets would do the job of monetary tightening for the Fed. The bond market is hoping the Fed will raise interest rates further to combat inflation and raise government borrowing costs, rather than just sit back and watch the data on a Bloomberg terminal. Interest rates are rising across the curve, and most worryingly, long-term rates are rising in a bear-market steep fashion, which is fatal to the financial system. KRE responded by falling to levels last seen at the height of the banking crisis in April. Yellen was forced to take action in November by converting the borrowings into Treasuries. This saved the bond market and triggered a vicious short-covering rally in stocks and bonds.

Hopium

The market is now predicting when RRP balances will approach zero and wondering what will happen next. Theres a lot of discussion about this, including speculation about how the Fed can increase liquidity without printing money. But no action has been taken yet. Two-year Treasury yields have recovered, but KRE prices continue to rise, and the market is drinking poison to quench its thirst. If Yellen and Powell are right, the 10-year Treasury yield will magically drop from 3% to 2%. This wont happen without new dollars to buy bonds. This is the disconnect between the 2-year Treasury yield and KRE. I believe the market is in for a nasty surprise as it becomes clear that Powell will only roar and not make any drastic changes.

This busy chart shows the difference between Bitcoin (white) and the 2-year Treasury yield (green), which tell the same story, while SPX (yellow) tells a different story. Since November 1, 2023, Bitcoin and the SPX Index have risen as the 2-year Treasury yield has fallen. Once the 2-year yield bottomed out and reversed direction, Bitcoin fell while the SPX continued to rise.

Bitcoin tells the world that the Fed is caught between inflation and a banking crisis. The Feds solution is to try to convince the market that the banks are sound without providing the necessary funding to make this illusion a reality.

fragile bottom

Jim Bianco has produced some excellent charts, which the remainder of this article will focus on.

As readers know, I spend the Northern Hemisphere winter in Hokkaido, Japan. One notable change this season is the sheer number of Americans. Even for those living in Asia, traveling to this powder paradise is a pain in the ass, and if you live in the United States, vacationing in Japan is even more time-consuming and expensive.

However, U.S. baby boomers are skiing at resorts in significantly greater numbers. Baby boomers are the wealthiest people in their lives. Thats because both the stock market and home prices are at historically high levels. Moreover, their cash reserves are generating income for the first time in decades, and for a group of humans who have had a near-close brush with death during the COVID-19 pandemic (mostly older, obese people known as baby boomers) are dying from the pandemic. Time to travel the world.

The richest 10% of households in the United States own approximately 65% ​​of the financial assets injected by the Federal Reserve through various money-printing programs. Baby boomers are the wealthiest generation, and their spending is powering a very strong U.S. economy.

The Atlanta Fed expects Q4 2023 GDP growth to be a strong +2.4% – strong, very strong!

However, the rest of the country is bankrupt and deeply in debt.

The top 10% hold about 65% of financial assets but only about 8% of debt. The bottom 90% hold 92% of the debt but only 35% of the assets.

This high inequality in the distribution of wealth and debt creates a problem for politicians in democracies. While politicians are determined to do whatever it takes to make the rich richer, they need to get elected by gaining the support of bankrupt civilians. Thats why when inflation occurs, its a problem.

The current Consumer Price Index (CPI) calculation method is Fugazi. If we go back to the CPI calculations of 1980 or 1990, the actual inflation rate was about +10%, while the inflation rate you read in the news was +3%.

Thats why, according to the latest polls, Trump is slightly more likely to beat Biden.

In short, American politics is like a circus where the wealthy buy ads to increase the popularity of their favorite clowns, who dance and sing to win the votes of the common people. Biden must hand out goodies to rich and poor alike to win. On a cynical macro level, the strategy is to pump up the stock market owned by the rich, thus increasing tax revenues, and then use the loot collected from the rich to provide relief to the poor.

The top 10% pay 74% of income taxes. Their huge contributions stem from huge capital gains taxes levied by governments during stock market gains. Therefore, the U.S. governments finances are tied to the performance of the stock market.

Biden has two financial generals with different missions. Yellen must use the power of the U.S. Treasury Department to boost stocks. She could do this by adjusting the Treasurys bond issuance schedule or by scaling back the TGA. Powell must reduce inflation to acceptable levels, which he can do by raising interest rates and shrinking the Feds balance sheet.

Yellens job is much easier than Powells. Yellen could unilaterally boost the stock market by issuing more Treasuries and bonds, or by reducing the TGA to zero from the current $750 billion. Powell can reduce the money supply and raise interest rates, but he has zero control over geopolitical issues. Nor can he influence the size of government deficits or surpluses. Assuming the government is committed to running large deficits, Yellen will provide funding appropriately, thereby increasing demand for goods and services. In this case, Powells anti-inflation actions at the Fed will be weakened.

The reason post-COVID-19 inflation in the United States has been so pronounced is because the government has given people stimulus funded by the Federal Reserves money printing at a time when shipping goods around the world has been difficult. There have been shutdowns and labor shortages due to coronavirus lockdowns and vaccine policies. The result has been inflation reaching levels not seen since the late 1970s and early 1980s.

A similar global supply chain crisis is unfolding, but this time, difficulties transporting goods are caused by El Niño and the closure of the Bab el-Mandeb Strait to Western ships.

Horn and Hope

Shipping is an old but important business. Sea transport has the cheapest cost per kilometer of travel compared to rail, road or air. Without the Panama Canal or Bab el-Mandeb Strait, ships would have to go around Cape Horn or the Cape of Good Hope. The onset of an El Niño weather pattern is causing drought in the Panama Canal, resulting in lower than average water levels in the canal, meaning fewer ships can pass through. Asymmetric drone warfare by Yemens Houthis has effectively blocked the Bab el-Mandeb Strait to Western shipping. They now had to sail around the Cape of Good Hope.

This diversion affects 20 to 30 percent of global shipments and adds significant time and expense. To an inflation statistician, anything that travels by boat becomes more expensive, all else being equal. Given that inflation operates with a considerable lag, if this continues, the effects will not be felt for several months. While markets were pleased with lower year-over-year inflation data in the U.S. and elsewhere, it could be a Pyrrhic victory.

The El Niño weather pattern is just beginning. Mild El Niño conditions typically last one to two years. No matter how severe this El Niño is, it will still happen this November. Sadly, if you are a Biden supporter, there is nothing he can do about the weather, and humans are not a Kardashev Type I civilization. El Niño and climate change in general have lowered water levels in the Panama Canal, reducing the number of ships that can transit.

Reducing shipping activity through the Panama Canal is important because the United States is rerouting some cargo through Europe to eastern seaboard ports to avoid passing through the Canal. However, shipping costs and times will increase given that cargo loaded on Western ships from Asia to Europe must now go around Africa rather than through the Red Sea.

The Houthis have declared that they will attack any ship from any country that supports Israel. They believe that Israels war in Gaza is an act of genocide, prosecuted by war criminals such as Prime Minister Bibi Netanyahu. In solidarity with their fellow Muslims and Arabs, they used $2,000 worth of drones to attack merchant ships. A cheap drone can completely disable a ship worth hundreds of millions of dollars, which is the definition of asymmetric warfare. Think about it: To disable a $2,000 drone, the United States would have to launch a $2.1 million missile. Even if the Houthis never hit a single target, the defense cost of each drone they send is 1,000 times higher than that of the United States. Mathematically, this is an unwinnable war for the United States.

The cost of using expensive Navy missiles (which can cost up to $2.1 million each) to destroy simple Houthi drones (estimated at thousands of dollars each) is a growing concern, according to three other defense officials. ——Politico (Political Newspaper)

Given that the United States, as the issuer of the global reserve currency, is responsible for global maritime security, the world is watching how Pax Americana responds to this blatant military strike. Judging from the Houthi armed forces statement, if the United States cuts off diplomatic relations with Israel and forces Bibi to end the war, the Houthi armed forces will stop their attacks. However, even if the United States believes that Bibi is a genocidal maniac, American imperialism will not abandon its allies because the government of a cesspool country launched a few cheap drones and closed one of the worlds most important waterways.

Even if Biden loudly calls on Bibi to end the war and stop the murder of so many Gazan men, women and children, Biden will never stop the financial and military blockade of the Israelis for fear of losing face. The result was that the entire world was in fear of the outbreak of war.

I predict that we will see firsthand how difficult it is for the mighty fists of red, white, and blue to defeat a swarm of drones. In order for shipping lines to have the confidence to cross the Red Sea again, the U.S. Navy must perform flawlessly in every engagement. Every drone must be destroyed. Because even a direct impact from a drone payload could incapacitate a commercial vessel. Additionally, with the United States now at war with the Houthis in Yemen, shipping insurance premiums will skyrocket, making sailing through the Red Sea even less economical.

Rising transportation costs due to weather and geopolitical factors could lead to a spike in inflation in the third and fourth quarters of this year. Since Powell is undoubtedly aware of these issues, he will make every effort to talk about a rate cut without necessarily actually cutting rates. Inflation is likely to rise modestly due to higher transportation costs, but interest rate cuts and the restart of quantitative easing are likely to exacerbate this rise. The market is not aware of this fact yet, but Bitcoin is.

The only thing better than fighting inflation is a financial crisis. Thats why, in order to achieve cuts, QT tapering, and the markets belief that QE may resume in March, we first need to have some banks fail when BTFP does not update.

tactical trading

After the ETF was approved, BTC’s range high of $48,000 corrected 30% to $33,600. Therefore, I believe Bitcoin will form support between $30,000 and $35,000. Thats why I bought $35,000 in puts on March 29, 2024, and also sold my Solana and Bonk trading positions at a small loss.

Bitcoin and cryptocurrencies in general are the last freely traded markets in the world. Therefore, they will predict changes in USD liquidity before the TradFi fiat stock and bond markets are manipulated. Bitcoin tells us to look for Yellen, not just talk.

Yellen has the opportunity to inject more energy into the market in the QRA that will be released on January 31. If she announces that she will cut the TGA from $750 billion to zero, then we know there is another source of liquidity that the market did not anticipate that could support the market. The question then becomes: will the BTFP be enough to prevent any bank failure if it is not updated?

I believe BTFP will not be updated as neither Yellen nor Powell mentioned it even once. So the natural assumption is that it will mature and banks will have to repay nearly $200 billion in borrowed money. If things change and they make it clear they will extend the deadline, then the game is on. I will close my puts and take advantage of maximum crypto exposure by continuing to sell Treasury bills and buy crypto.

If my base case prediction comes true, I will start buying the dip once Bitcoin drops below $35,000 and continue to buy Solana and WIF.