The Breakdown - What the Fed’s ‘Hawkish’ Turn Means for Bitcoin

Episode Date: December 17, 2021

This episode is sponsored by NYDIG. Yesterday in the wake of the FOMC meeting, the Federal Reserve signaled a hawkish turn. Asset purchases will be tapered at twice the speed, and the Fed is now anticipating three rate hikes next year. So why, in the wake of all that, are risk assets going up, and five-year inflation expectations climbing?  Enjoying this content?   SUBSCRIBE to the Podcast Apple:  https://podcasts.apple.com/podcast/id1438693620?at=1000lSDb Spotify: https://open.spotify.com/show/538vuul1PuorUDwgkC8JWF?si=ddSvD-HST2e_E7wgxcjtfQ Google: https://podcasts.google.com/feed/aHR0cHM6Ly9ubHdjcnlwdG8ubGlic3luLmNvbS9yc3M=   Join the discussion: https://discord.gg/VrKRrfKCz8   Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW NYDIG, the institutional-grade platform for bitcoin, is making it possible for thousands of banks who have trusted relationships with hundreds of millions of customers, to offer Bitcoin. Learn more at NYDIG.com/NLW. “The Breakdown” is written, produced by and features Nathaniel Whittemore aka NLW, with editing by Rob Mitchell, research by Scott Hill and additional production support by Eleanor Pahl. Adam B. Levine is our executive producer and our theme music is “Countdown” by Neon Beach. The music you heard today behind our sponsor is “Dark Crazed Cap” by Isaac Joel. Image credit: Michael Nagle/Bloomberg/Getty Images, modified by CoinDesk.  

My point is that every time Bitcoin seems correlated to a macro event, people come out of the woodwork to critique it for that when it's really not that complicated and it doesn't somehow hand-wavily undermine Bitcoin. The difference in Bitcoin has always been and will always be the large and growing group of hoddlers who are not affected by macro events and Fed policy changes and who continue to deepen their exposure and provide an ever-increasing floor for this asset. Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big-picture power shifts remaking our world. The breakdown is sponsored by Nidig and produced and distributed by CoinDesk.

What's going on, guys? It is Thursday, December 17th. And if you are a regular listener, you will have heard throughout 2021 that the central macroeconomic battle, the battle, that has defined, at least mainstream media coverage of U.S. markets, has been all about the threat and then the reality of inflation. The question has been, how long could the Fed keep the pedal on the metal to help bring the economy back in a post-COVID or at least post-vaccine COVID world versus having to turn hawkish to fight growing inflation? Part one of the year was what we'll call the transitory phase. During this phase, as inflation started to show up, the Federal Reserve

aggressively stuck to the notion that any inflation was simply transitory. It was caused by supply chain dislocations in the wake of COVID-19 shutdowns and a supply demand mismatch. This makes sense in a theoretical way, right? We had gone from near zero demand in a lot of areas during shutdowns to not only the return of normal demand, but a catch-examination. up demand that exceeded normal demand because people hadn't been engaging in their normal economic activity. Meanwhile, on the supply side, you have all sorts of manufacturers, producers, suppliers who haven't been doing anything, who have also been shut down, who have to get their capacity back up and running. And so they're not even able to meet normal demand, and we've exceeded

into extra normal demand. The point here is that there's a real supply demand mismatch, and that's why the Fed said that they perceived inflation to be largely transitory. However, markets didn't really buy it. The reaction of markets throughout the year, and really especially since April and May, has been to more or less reject the notion that this inflation is transitory. And effectively, the argument the market has been making is that inflation was going to force the Fed's hand, that they weren't going to be able to continue to preside over the sort of bond purchasing programs they had and near-zero interest rates they had for very long. Part two of the year was what we'll call maybe a little less transitory, where the Fed started to give itself a new narrative positioning that admitted that inflation was a little bit more persistent than they perhaps understood.

As numbers of the CPI inflation prints rose and rows, this narrative shift proceeded farther and further. And in some ways, I think this part two of the year culminated with the renomination of Jerome Powell as Fed Chair. The speeches that surrounded that renomination signaled a strong shift to focus on inflation fighting. And this makes sense because it was becoming a political issue for the Biden administration. Increasing prices in things like cars and food and all of these things that affect people's lives day and day out are showing up in polls around Biden's performance. And remember, we're heading into midterms next year. With yesterday's FOMC meeting, we've now entered part three of the year. year, with the Fed making what Bloomberg called, quote, one of the most hawkish pivots.

Here's what was announced yesterday. First, they're doubling the pace for scaling back purchases of treasuries and mortgage-back securities. They've gone from $80 billion a month, down to $70 billion a month, and they'll soon be down to $30 billion a month. These purchases will conclude in early 2022, rather than in the middle of next year, as previously articulated. The Fed also projected three-quarter-point increases in the benchmark federal funds rate next year. Remember, in September, Fed officials were evenly split on the need for any rate hikes at all in 2022, so this is a big shift. They also anticipate another three increases in 2023 and two in 2024, which would bring the rate to 2.1% by the end of that year.

Let's talk about the narrative of the shift. Powell said, economic developments and changes in the outlook warrant this evolution of monetary policy. The economy has been making rapid progress towards maximum employment. So why is that statement necessary? Well, the Fed has a dual mandate, stability on the one hand, but maximum employment on the other. Its justification for letting inflation run hot has been to try to get farther and make more progress on full employment. There are also some real thorny issues there that were unexpected, like the declining participation rate in the economy and people dropping out of the workforce altogether.

So now, basically, what the Fed is doing is that, in the Fed is that, Instead of saying, it doesn't matter if we still have a long way to go on employment, we got to tamp down on this inflation, they're saying, actually, we're doing great on the employment, so we can undertake policies, which will put the lid on an inflation which could get problematic in the future. Still, though, the real interesting part about this meeting was the market's reaction. The market was anticipating some acceleration. They might have been anticipating some rate hikes. But the thing that they were watching out for, more than that, was a Volker moment, something that harkened back to Paul. Volker, when he plunged effectively the economy into recession in order to tamp down runaway inflation at the end of the 70s. The question that markets had was whether Powell was going to go on a crusade to fight inflation even at the cost of asset prices.

The market's reaction yesterday, why the S&P 500 closed near all-time highs, was because it's clear that he's not. Sam Stoval, the chief investment strategist at CFRA research, said, equity prices turned from red to green, likely because the uncertainty had been lifted, and Fed Chair Powell didn't sound as hawkish as many had feared. History says, but does not guarantee, that prior Fed tightenings resulted in minor price increases for the equity markets over the ensuing year. John authors at Bloomberg wrote a long opinion piece about this, saying, the upward shift in acceleration in rate hikes over the next three years is very evident. This was a meaningful escalation. But the longer-term projection for

the terminal rate is unchanged. The Fed governors still believe that rates will never need to go higher than 2.5%, where Fed funds peaked in 2019 during the abortive attempt to return rates to normal after the financial crisis. There's still no belief at the Fed that inflationary conditions are normalizing, or that we are returning to the kind of pre-2008 world, where central bank vigilance against rising prices will once more need to be a fact of life. Instead, there's a hope that inflation can be brought under control with relative ease. The market appears to endorse this and also to believe that there will be no need for the extra rate hikes in 2023 and 2024 predicted in the dot plot. For all the world, it looked as though the Fed chairman tipped the wink to his audience that he wasn't

going to try too hard to contain inflation, and not to worry. For yet another sign of the same pattern, stocks zoomed back to close to an all-time high. The big tech names that dominate the NASDAQ 100 index had been particularly dented initially and enjoyed the strongest comeback. They have been viewed this year as sensitive to rates. Lower rates are taken as a reason to invest in the stocks of companies that reliably produce huge amounts of cash. Those qualities again seem exciting as investors feel comfortable that rates won't go that high. NIDIG sponsors this podcast, and they are the go-to Bitcoin company for banks and credit unions as well as corporate treasuries, fintechs, and hedge funds.

Learn more at nidig.com slash NLW. That's nydig.com slash NLW. A lot of the reaction on Twitter followed sort of from this. Positioning in many ways the choices that the Fed was making as Main Street on the one hand, Wall Street on the other. Main Street is hurt by high inflation. The cost of living goes up. Wall Street, on the other hand, benefits from policies which maybe produce inflation, but which also keep money cheap and asset prices high. During Powell's press conference, inflation expectations went up over the long term. After an initial sharp decline, as he started talking, as he answered

questions, they actually went up. The market dog interprets this saying the market agrees that inflation will run wild. Finally understand Powell doesn't care about peasants. Powell gave an answer about why not just stop asset purchases now and needing to be methodical. And Jim Bianco translated as this, saying, Translated, the Fed is very careful to not upset markets. And if the markets ever get upset with anything the Fed does, they will immediately reverse. So even though the Fed is going to be tightening soon, risk on, they will never upset the stock market. Macroscope tweeted all you have to know about the Fed.

One, in coming weeks and months if market turns lower, will quickly leak Dovish comments to media. Two, we'll look for any excuse at all to go dovish. Three, we'll say what markets want to hear on any given day. Goes double in a midterm election year. I do have to say that the Fed is walking a very tight line of interests. They have the market interest on the one hand. They have the concern about inflation on the other. But then within that, they also have a variety of other push-and-pull factors

that are potentially dragging them in different directions. A new variant in Omicron and what that might mean presents a threat to stability, and so that increases the risk of changing policy to the hawkish side too fast. Labor participation and declining labor participation still is an unsolved issue. The extent to which inflation is driven by supply chain dislocations versus being driven by the pernicious cycle of price increases and wage increases is yet another dimension of this whole conversation. Let's talk about whether Powell talked about crypto, because he did in fact do so.

He discussed the Fed's overall picture of financial stability risk. Their framework, he said, was asset valuations, debt owed by households and businesses, funding risk, and leverage among financial institutions. On asset valuations, he called them somewhat elevated. The debt of households, he said, was in strong financial shape. When it comes to businesses, they're in debt, but they have very low default levels. They consider the funding risk low, although money market funds are a vulnerability, and they consider leverage low in the sense that capital in the system is high. The risks that they point to are the pandemic worsening and cyber attacks, but not crypto.

Powell said on crypto, concerns there are not so much current financial stability concerns. I would, of course, support the views expressed in the president's working group report on stablecoins. Stablecoins can certainly be a useful, efficient consumer-serving part of the financial system if they're properly regulated, and right now they aren't. I do think those are longer term in terms of the cryptocurrencies that are really speculative assets. I don't see them as a financial stability concern at the moment. I do think they're risky, they're not backed by anything. I think there are big consumer issues for consumers who may or may not understand what they're getting. There's certainly developments in the markets that are worth following, which are not really in our jurisdiction. Things like the leverage that's built

into them and those sorts of things is certainly worth watching. So I think the key takeaway for sure is Fed Chair doesn't consider crypto a financial stability risk at this time. The second part, though, is the Fed really has a relatively minor role in the next phase of regulation compared to a lot of other government bodies. Now, one of the other points of discussion following the Fed meeting was the crypto market's correlation. As stock started to go up, so did crypto. Alex Kruger tweeted, I don't think I've ever seen crypto traders talk so much macro ever before. Joe Wisenthal said, I've never seen crypto Twitter so focused on a Fed decision before, but I guess it makes sense now that Bitcoin at all are just regular old high beta correlated risk assets.

Basically just stocks at this point, really. Jeff Dorman says, crypto investors, leave us alone, governments, we built all of this without your help. Also, our entire fate hinges on today's FOMC meeting. Note, the largest rally, 1617, happened when the Fed actually raised rates and largest sell-off happened when they lowered rates, second half 19. Dave Weisberger followed up. Good observation, Jeff. Unless one thinks the Fed is going full vulgar to crush inflation expectations, gradual rate increases that keep real rates negative indefinitely is bullish for Bitcoin.

It signals the Fed realizes they're losing control of monetary value. Now, I have a slightly different take, and I appreciate the trolling as much as anyone, but of course correlation is growing in these assets. It's not because all of the hoddlers of Bitcoin all of a sudden, give a crap about what the Fed has to say. It's because, one, there is now, after 18 months of the institutionalization of Bitcoin and crypto, huge overlap with market participants who do pay attention to what the Fed does, and who do consider Bitcoin structurally just another risk stock. When you have some meaningful, knowable part of your market who operates on the modality

of the stock market for their Bitcoin risk asset, yes, correlation is going to increase. Shocker. Second, there are traders who didn't use to pay attention to the macro who realized that because of number one, because of the entrance of this new market participants and the natural correlation increase they bring, that it also makes sense for them to pay attention to the macro because those could be buy and sell the news type events. My point is that every time Bitcoin seems correlated to a macro event, people come out of the woodwork to critique it for that when it's really not that complicated, and it doesn't somehow hand-wavily undermine Bitcoin. The difference in Bitcoin has always been and will always be the large and growing group of hoddlers who are not affected by macro events

and Fed policy changes and who continue to deepen their exposure and provide an ever-increasing floor for this asset. But anyways, I digress. Others also have different interpretations. Three-Ros Suu said, Crypto Market has used macro as an excuse to sell off when it has actually done so for mostly unrelated reasons. Overvalued alts, year-end redemption flows, tax selling, Huobie account closures, log welders, all of which are unironically transitory. Prepare accordingly. But let's sum up the Fed's meeting from yesterday. Daniel LaCalle, who's been on the show before, said the most doveish, hawkish statement ever. And as an interesting twist, the Bank of England this morning announced rate increases. Andrew Bailey, the governor of the BOE, said, we've seen evidence of a very

tight labor market and we're seeing more persistent inflation pressures, and that's what we have to act on. We're concerned about inflation in the medium term, and we're seeing things now that can threaten that. The BOE is now the first major central bank to raise rates since the beginning of the pandemic, up 15 basis points to 0.25% and expecting more in February. So, as I started this off, we're officially in a new era of monetary policy. The inflation fight has come. Will it actually impact inflation at all? How will politics impact how much or how little central banks can get away with when it comes to moving to the hawkish? Will crypto, now that there's more clarity around what the Fed is going to do, go back to not caring? All of these are the questions that I will be watching,

and I appreciate you hanging out as we do. Until tomorrow, guys, be safe and take care of each other. Peace.