Arthur Hayes: Rally back down or long-term bull market? The Fed’s steering will determine everything |

Arthur Hayes: Rally back down or long-term bull market?  The Fed’s steering will determine everything |

If the U.S. Federal Reserve (Fed) does implement an interest rate shift, Bitcoin will continue to perform strongly and this rally will be the start of a long-term bull market. This article is derived from the Medium article “Bouncy Castle” by BitMEX founder Arthur Hayes, organized, compiled and written by WuBlockchain, the dynamic column. (Recap:Arthur Hayes: SBF has won the trust of social elites and employers with its “successful white male” personality ) (Background Supplement:Popular Science | What is the U.S. dollar index? Inflation, Fed rate hikes, breaking 20-year highs are bad for cryptocurrencies?)

DownAs can be seen in the graph, inflation, as measured by the (flawed and misleading) Consumer Price Index (CPI) series released by the U.S. Bureau of Labor Statistics, peaked at around 9% in mid-2022 and is now heading towards The critical 2% level fell sharply.


There are many who believe that the recent steady downward trend in the CPI can only mean one thing: Powell is ready to put the water back on, as in March 2020. With the U.S. and possibly the world on the brink of recession, those prognosticators would say that Powell is looking for every opportunity to move away from his current quantitative tightening (QT) policy, which will take a lot of the burden if we enter a recession. A large part of the responsibility. With the CPI down, he can now point to the drop and say that his just campaign to kill the beast of inflation has succeeded, and he can now safely turn the tap back on.

I’m not so sure these predictions are correct, but we’ll have more to say later. Now, let’s assume the market thinks this is the most likely path forward, so how can we expect Bitcoin to react? To model accurately, we must remember two important things about Bitcoin.

Further reading:Popular Science | What is the U.S. dollar index? Inflation, Fed rate hikes, breaking 20-year highs are bad for cryptocurrencies?

Further reading:Arthur Hayes: The founder of DCG is a financial parasite, borrowing money from Genesis to buy GBTC

First, Bitcoin and the broader crypto capital market are the only ones that are truly immune to manipulation by central bankers and large global financial institutions. You may ask:

“But what about alleged wrongdoing by bankrupt companies like 3AC, FTX, Genesis, Celsius, etc.?”

This is a fair question, but my answer is that as the crypto market prices corrected and these companies went out of business, the market quickly found a much lower liquidation price at which leverage was wiped out system. Had the same reckless behavior happened in the TradFi system, the authorities would have tried to delay the reckoning of the market by propping up failing entities (which they have always done), and in the process destroying the very economy they were supposed to protect, But the cryptocurrency space has faced serious challenges and quickly cleaned up poorly run businesses with flawed business models, setting the stage for a quick and healthy rebound.

The second thing to remember about Bitcoin is that because it is a reaction to the profligacy of the world’s global fiat currency system, its price is heavily dependent on the future path of the dollar’s global liquidity (due to the dollar’s role as a global reserve currency). I have written about this concept and my USD Liquidity Index at length in a recent article. To this end, Bitcoin has outperformed the flat USD Liquidity Index over the past two months. In my opinion, this shows that the market believes that the Fed’s turn has come.

Gold Yellow Bitcoin Green Dollar Liquidity Index White Index 100
Gold Yellow Bitcoin Green Dollar Liquidity Index White Index 100

Looking at the price trend of Bitcoin, it is currently pulling up from a low. From here, we can identify a few different potential paths forward based on what is actually driving the rally:

Rally Catalyst Scenario 1: Bitcoin just experienced a natural rally from local lows below $16K.

If this rally is really just a natural bounce off local lows, I would expect Bitcoin to then find a new platform and move sideways until USD liquidity conditions improve.

Rally Catalyst Scenario 2: Bitcoin rises as the market beats the Fed to resume printing money. If that’s the case, I think two things could happen:

Scenario 2A: If the Fed does not implement the steering, or several Fed officials are not optimistic about the expectations of the steering after the CPI data is “good”, Bitcoin may fall back to the previous low. Scenario 2B: If the Fed does implement a pivot, Bitcoin will continue to perform strongly and this rally will be the start of a long-term bull market.

Clearly, we would all like to believe that we are moving towards Scenario 2B. That said, I think we’re actually going to be facing some combination of Scenarios 1 and 2A, which makes my itchy “buy” finger a bit hesitant.

While I believe the US Fed will turn around, I don’t think it will happen just because the CPI is trending lower. Powell declared that he was more concerned with the interplay between wage growth (U.S. hourly wages) and core personal consumption expenditures (core PCE) rather than relying on the CPI as a measure of inflation.

As an aside, I don’t think CPI nor core CPE are good indicators of inflation. Core PCE is especially hypocritical because it excludes food and energy. Civilians don’t riot because the price of a flat-screen TV goes up, they riot because the price of bread goes up 100%. But no matter what I think, what’s important to our forecasting work is that Powell has telegraphed that he intends to base any decision on potential policy shifts not only on CPI but also on the growth in US wages versus core personal consumption expenditures Compared.

Change in U.S. Hourly Earnings minus Change in Core PCE are both %YoY growth
Change in U.S. Hourly Earnings minus Change in Core PCE are both %YoY growth

As you can see from the chart above, average wages in the US are growing at the same rate as inflation. This means that while goods are getting more expensive, people’s ability to buy them is actually growing at a similar rate due to rising wages.

Therefore, the increase in people’s purchasing power may further promote commodity inflation. In other words, commodity producers may realize that their buyers are now making more money than before and raise prices further to absorb more of buyers’ recent wage increases, all without fear of stifling demand for their products. So Powell actually has a case for continuing to raise interest rates (i.e. curbing consumer demand and preventing further increases in commodity prices). And he’s likely to use it, since he’s already said he’s looking to ensure that yields across the U.S. Treasury curve are above inflation (yet).

U.S. Treasury Activity Curve
U.S. Treasury Activity Curve

December 2022 core personal consumption expenditures rose 4.7% YoY. As you can see from the above curve, only the 6-month Treasury bill currently yields more than 4.7%. So Powell has a lot of wiggle room to keep raising rates. More importantly, continue to shrink the Fed’s balance sheet and further tighten monetary conditions to the level he wants.

The point of these last few charts and some of the remarks is simply to suggest that the falling CPI number is meaningless because it is inconsistent with the actual metric Powell is using to judge whether the Fed is successfully taming inflation. The drop in CPI could mean something, but I don’t think it will predict in any meaningful way when the Fed will eventually turn around.

That said, I do believe that if Powell ignores the CPI data and continues to shrink the Fed’s balance sheet via QT, it will cause serious disruption in the credit markets and force them to pivot aggressively.

Since reaching a high of $8.965 trillion on April 13, 2022, the Fed’s balance sheet has shrunk by $458 billion as of January 4, 2023. The Fed was supposed to shrink its total balance sheet by $523 billion in 2022, so they’ve achieved 88% of their goal. Current QT rates suggest that the balance sheet will fall by another $100 billion per month and another $1.2 trillion in fiscal year 2023. If taking out $500 billion in 2022 resulted in the worst bond and stock performance in centuries, imagine what would happen if taking out double that amount in 2023.

The market reacts asymmetrically when it injects and withdraws funds. Therefore, I expect the law of unintended consequences to bite the Fed’s ass as it continues to withdraw liquidity. I also believe Powell understands this instinctively because, as aggressive as his QT is, at current rates it will take many years to fully reverse the amount of money printing since the start of the COVID-19 pandemic. From mid-March 2020 to mid-April 2022, the Fed printed $4.653 trillion. Based on a monthly reduction of US$100 billion, it will take about 4 years to fully return to the pre-epidemic Fed balance sheet level.

If the Fed really wants to reverse money growth, it should sell MBS and Treasuries outright, rather than just stop reinvesting in maturing bonds. Powell could have stepped up the pace, but he didn’t, suggesting he knows the market can’t afford the Fed to dump its assets. But I still think he overestimated the market’s ability to deal with the Fed’s continued passive involvement. The MBS and Treasuries markets need liquidity from the Fed, and if QT continues to grow at the same rate, these markets, and all other fixed income markets that derive their valuations and pricing from these benchmarks, will soon be in a world of pain.

In my opinion, two things might prompt the Fed to pivot:

1. Powell believes that the decline in the CPI indicator confirms that the Fed has done enough to pause rate hikes at some point in the near future, possibly halting QT and cutting rates if there is a mild recession in 2H23. Monetary policy typically has a lag of 12 to 24 months, so Powell sees CPI trending down and can be confident that based on what has happened over the past year, inflation will continue to return to the Holy Grail of 2% in the near future. As I outlined above, I think this scenario is unlikely since I don’t think Powell uses the CPI as a measure of inflation, but it’s not impossible either.

2. Parts of the U.S. credit market collapse, leading to a financial meltdown involving a broad range of financial assets. In a similar response to March 2020, the Fed held an emergency press conference, halted QT, slashed rates, and restarted QE by buying bonds again.

In Scenario 1, I expect risky asset prices to rise slowly. We’re not going back to the 2022 lows, and it’s going to be a pleasant environment for fund managers. Just sit back and watch the base effects of the CPI kick in, mechanically lowering the headline numbers. The U.S. economy will find itself in an average position, but nothing terribly bad will happen. Even a mild recession would not be like what we saw during March-April 2020 or during the 2008 global financial crisis. Of the two, it’s the preferred one, as it means you can start buying now, before the economy gets better and inflation stays low.

In Scenario 2, risky asset prices plummet. Bonds, stocks, and every cryptocurrency under the sun will be blackened as the glue of the dollar-based global financial system dissolves. Imagine the US 10-year treasury yield quickly doubling from 3.5% to 7%, the S&P 500 falling below 3000, the Nasdaq 100 falling below 8000, and Bitcoin trading at 15,000 or less trade.

Like a deer caught in headlights, I expected Sir Power to mount his horse and lead an army of money printing to the rescue. This is less than ideal, as it means that everyone buying risky assets now will face a significant downturn in performance. 2023 could be as bad as 2022 before the Fed turns.

My guess is scenario 2.

Why did gold go up?

Gold (yellow), Bitcoin (green), USD Liquidity Index (white), with an index of 100
Gold (yellow), Bitcoin (green), USD Liquidity Index (white), with an index of 100

The most plausible rebuttal to my underlying assumption for Scenario 2 is that gold also rises along with Bitcoin. Gold, a more liquid and trustworthy anti-fragile asset, serves a similar purpose in that it is also a hedge against the fiat currency system. So at first glance, you might reasonably surmise that gold’s recent gains are further evidence of the market’s belief that the Fed will adjust policy in the near future. That’s a reasonable inference, but I suspect gold is up for another reason entirely. Therefore, it is important not to confuse the rise of gold and bitcoin as joint confirmation that the Fed is about to turn. let me explain.

Gold is sovereign money because, at the end of the day, nation-states can always settle trade in goods and energy in gold. This is why every central bank has a certain amount of gold on its balance sheet.

Since each central bank holds a certain amount of gold, when a country’s currency must be devalued to remain globally competitive, central banks always resort to devaluing gold. As a recent example, the United States devalued the dollar against gold in 1933 and 1971. That’s why I have a large allocation of physical gold and gold miners in my portfolio. It is always better to invest alongside the central bank than against it.

I (and many others) have written extensively about how de-dollarization of the world will accelerate in the coming years following several key recent geopolitical events such as the US freezing of Russian “assets” held in the Western financial system article. I predict that sooner or later the world’s producers of cheap labor and natural resources will realize that if they piss off the American states they could face the same fate as Russia, and that there is no point in hoarding wealth in US Treasuries. This makes gold the most obvious and attractive investment destination.

The data supports the view that governments are turning to the time-honored sovereign reserve currency, gold, to store wealth. The chart below goes back 10 years and depicts net gold purchases by central banks. As you can see, we hit an all-time high in the third quarter of 2022.

Net purchases of gold by central banks in metric tons
Net purchases of gold by central banks in metric tons

The peak of cheap energy has arrived, and many heads of state recognize it. They instinctively know, like most people, that gold is a better purchasing power in terms of energy (crude oil) than currencies like the dollar.

This excellent chart from Gavekal Research clearly shows that gold is a better store of energy than US Treasuries.

In my view, these data suggest that gold prices are rising more because of real physical demand than because the world’s central banks think the Fed will turn. Of course, at least some of this is due to expectations that the Fed’s monetary policy may ease in the near future, but I don’t think those expectations are the driving force behind it.

transaction preparation

What if I’m wrong and Scenario 1 happens with good economy and low inflation?

This means that I have missed the bounce off the bottom and Bitcoin is unlikely to turn back as it is relentlessly marching towards new all-time highs. If true, the rate hike could come in two phases. In the first phase, savvy speculators will be ahead of the actual shift in Fed policy. At this stage, Bitcoin can easily trade to $30,000-$40,000, as the current price is heavily depressed by the post-FTX bearish sentiment. The next phase will take us to $69k or more, but it will only start after a lot of dollars are injected into the crypto capital markets. Such an injection would require at least a pause in rate hikes and QT.

If I’m wrong, I’d happily miss the initial chance to bounce off the bottom. I’m already long, so I benefit anyway. However, my USD holdings in the form of T-bills would suddenly underperform, and I would need to reallocate those funds into Bitcoin to maximize my return on investment. Before I give up on the bonds I bought at 5% yields though, I want to have a high level of confidence that the bull market is back. 5% is obviously below inflation, but it’s better than a 20% drop because I mistimed the market and bought risky assets too early in the next cycle.

When they do decide to pivot, the Fed will communicate clearly in advance that they will abandon tightening monetary policy. The Fed told us at the end of 2021 that they will turn to fighting inflation by restricting the money supply and raising interest rates. They followed through and started doing so in March 2022, and anyone who didn’t believe them was slaughtered. So the same thing is likely to happen in the other direction, i.e. the Fed will tell us when it’s over, and if you don’t believe them, you’ll miss out on the ensuing surge.

Since the Fed hasn’t signaled to turn yet, I can wait. I think the first is capital preservation, and the second is growth. I’d rather buy a market that has bounced 100%+ off the lows after the Fed communicated the turn than buy a market that bounced 100%+ off the lows because the turn didn’t happen and then crashes due to poor macro fundamentals Suffer 50%+ pullbacks.

If I’m right and Catastrophic Scenario 2 happens (ie global financial collapse), then I have another opportunity to buy the bottom line. I will know that the market may have bottomed because the crash that happens when the system crashes temporarily either holds the previous low of $15800 or it doesn’t. It doesn’t matter where the downside ends up, as I know the Fed will then act to print money and avoid another financial meltdown, which in turn will mark the bottom for all risk assets. Then I got another March 2020-like scenario, stepping up to buy crypto.

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