Original title: Sugar High

Original author: Arthur Hayes, founder of BitMEX

Original translation: TechFlow

(Any opinions expressed here are the author's personal opinions and should not be used as the basis for investment decisions, nor should they be interpreted as advice to participate in investment transactions.)

I ended my summer vacation in the northern hemisphere and went skiing in the southern hemisphere for two weeks. Most of my time was spent on backcountry skiing trips. For those of you who have not experienced this activity, the process is to attach ski skins to the bottom of the skis so that you can slide upwards. Once you reach the top, take off the ski skins, adjust the boots and skis to downhill mode, and enjoy the rich powder snow. Most of the mountains I went to can only be reached this way.

A typical four to five hour ski day consists of 80% uphill skiing and 20% downhill skiing. As such, this activity is energy intensive. Your body burns calories to maintain body temperature and homeostasis. Your legs are the largest muscle group in your body and are always working whether you are skiing uphill or downhill. My basal metabolic rate is around 3000 kcal, and with the energy required for leg work, my total daily energy expenditure is over 4000 kcal.

Due to the sheer amount of energy required to complete this activity, the combination of foods I consume throughout the day is critical. I eat a large breakfast in the morning that includes carbohydrates, meat, and vegetables; what I call "real food." Breakfast fills me up, but these initial energy reserves are quickly depleted as I head into the cold woods and begin the initial ascent. To manage my blood sugar levels, I keep snacks that I normally avoid, just like Su Zhu and Kylie Davies did to avoid a liquidator appointed by the BVI bankruptcy court. I eat an average of a Snickers bar and syrup every 30 minutes, even if I'm not hungry. I don't want my blood sugar levels to drop too low and affect my performance.

Eating sugary processed foods is not a long-term solution to my energy needs. I need to consume "real food" as well. After each completed lap, I usually stop for a few minutes, open my pack, and eat the food I prepared. I prefer a crisper with chicken or beef, sautéed leafy greens, and lots of white rice.

I pair the periodic sugar spikes with longer burning, clean, real food to keep me going throughout the day.

My purpose in describing the pre-meal preparation for a ski trip is to elicit a discussion about the relative importance of the price versus quantity of money. To me, the price of money is like the Snickers and syrup I eat, giving me a quick glucose boost. The quantity of money is like the slow, long-lasting burning "real food." At last Friday's Jackson Hole central bank conference, Powell announced a policy shift, with the Federal Reserve (Fed) finally committing to lowering policy rates. In addition, officials from the Bank of England (BOE) and the European Central Bank (ECB) also said they would continue to lower policy rates.

Powell announced the shift at approximately 9:00 a.m. GMT-6, corresponding to the red oval. Risk assets, represented by the S&P 500 (white), gold (yellow), and Bitcoin (green), all rose as the price of money fell. The U.S. dollar (not shown) also weakened over the weekend.

The initial positive reaction of the market is justified as investors believe that assets priced in fixed supply fiat currencies should rise if money becomes cheap. I agree with this view; however…we forget that future expected rate cuts by the Fed, Bank of England and ECB will reduce the interest rate differential between these currencies and the yen. The risk of the yen carry trade will re-emerge and could spoil the party unless the amount of money is increased in the form of central bank balance sheet expansion, i.e. printing money.

Please read my article Spirited Away for an in-depth discussion of this yen carry trade. I will be referring to this phenomenon frequently in this article.

USD strengthened by 1.44% against the yen, while USDJPY fell immediately after Powell announced the policy shift. This is expected, as the expected USD/JPY interest rate differential will narrow due to falling USD rates and flat or rising JPY rates.

The rest of this article seeks to delve deeper into this point and look ahead to the critical moments in the coming months before an apathetic US electorate elects Trump or Biden.

Premise of the Bull Thesis

As we observed in August this year, a rapidly appreciating JPY spells danger for global financial markets. If rate cuts in the three major economies lead to an appreciation of the JPY against their domestic currencies, then we should expect a negative market reaction. We are faced with a battle between positive (rate cuts) and negative (JPY appreciation) forces. Given that the total amount of global financial assets financed in JPY exceeds tens of trillions of dollars, I believe that the negative market reaction to the JPY carry trade caused by a rapidly appreciating JPY will outweigh any benefit from a minor rate cut in the USD, GBP or EUR. Furthermore, I think policymakers at the Federal Reserve (Fed), Bank of England (BOE), and European Central Bank (ECB) realize that they must be willing to ease policy and expand their balance sheets to offset the adverse effects of a stronger yen.

In line with my skiing metaphor, the Fed is trying to get the "sugar rush" of rate cuts before hunger sets in. From an economic perspective, the Fed should be raising rates, not cutting them.

The manipulated U.S. Consumer Price Index (white) has risen 22% since 2020. The Fed's balance sheet (yellow) has increased by more than $3 trillion.

The U.S. government is running record deficits, in part because the cost of issuing debt has not been limited enough to force politicians to raise taxes or reduce subsidies to balance the budget.

If the Fed truly wants to preserve confidence in the dollar, it should raise rates to curb economic activity. This will keep prices down for everyone, but some people will lose their jobs. It will also rein in government borrowing because the cost of issuing debt will rise.

The U.S. economy has only experienced two quarters of negative real GDP growth post-COVID. This is not a weak economy that needs rate cuts.

Even the most recent estimate for Q3 2024 real GDP is at +2.0%. Once again, this is not an economy that is suffering from overly restrictive interest rates.

Just as I eat candy and syrup when I’m not hungry to keep my blood sugar levels from dropping, the Fed is committed to never letting financial markets stagnate. The U.S. is a highly financialized economy that needs consistently rising fiat asset prices to keep the populace feeling wealthy. On a real level, stocks are flat or down, but most people aren’t paying attention to their real returns. Stocks that are rising nominally also increase capital gains tax revenue on the fiat side. In short, falling markets are bad for Pax Americana’s financial health. As a result, Yellen began interfering with the Fed’s rate hike cycle in September 2022. I believe Powell, at the direction of Yellen and Democratic leaders, is sacrificing himself by cutting rates when he knows he shouldn’t.

I show the chart below to illustrate what happened to stocks when the U.S. Treasury, under Yellen’s watch, began issuing large amounts of T-bills, draining flows from the Fed’s Reverse Repo Program (RRP) and into broader financial markets.

To understand what I said in the previous paragraph, refer to my article Water, Water, Every Where.

All prices are based on 100 on September 30, 2022; this was the peak of RRP, which was about $2.5 trillion. RRP (green) is down 87%. The nominal fiat dollar return of the S&P 500 (gold) is up 57%. I believe that the US Treasury has more power than the Fed. The Fed was raising the price of money until March 2023, but the Treasury found a way to increase the amount of money at the same time. The result was a nominal stock market boom. When priced in gold, the oldest form of actual money (the others are fiduciary money), the S&P 500 (white) is up only 4%. When priced in Bitcoin, the newest and most solid currency, the S&P 500 (magenta) is down 52%.

The US economy is not hungry for rate cuts, but Powell will provide a sugar rush. Because monetary authorities are extremely sensitive to any decline in fiat stock prices, Powell and Yellen will soon provide "real food" in some form, namely, expansion of the Fed's balance sheet, to offset the impact of the appreciation of the yen.

Before discussing the appreciation of the yen, I want to quickly talk about Powell's spurious rationale for lowering interest rates and how this further strengthens my confidence in rising risk asset prices.

Powell made his adjustments based on a terrible jobs report. U.S. President Biden's Department of Labor (BLS) released a shocking revision to the previous employment data a few days before Powell's speech at Jackson Hole, stating that the employment estimate was about 800,000 too high.

Biden and his dishonest economist supporters have been claiming the strength of the labor market during his administration. This labor market strength puts Powell in a dilemma as top Democratic Senators, such as Elizabeth "Pocahontas" Warren, call on him to cut interest rates to stimulate the economy so that Trump does not win the election. Powell faces a dilemma. Powell can’t cut rates on the grounds of falling inflation, as inflation is above the Fed’s 2% target. He also can’t cut rates on the grounds of a weak labor market. But let’s sprinkle a little political misdirection smoke on this situation and see if we can help our beta cuck towel bitch boy.

Biden was dumped by the Obamas after he acted like a vegetable on prescription drugs during his debate with Trump. He was replaced by Kamala Harris, who, if you believe the mainstream media reports, had nothing to do with any of the policies implemented by the Biden/Harris administration over the past four years. Therefore, the BLS can admit their misstep without it affecting Harris, who was never actually involved in the administration she was Vice President for. Such an amazing political masterstroke.

Powell could have used this opportunity to blame the weak labor market for the rate cuts, but he didn’t. Now he’s announced that the Fed will start cutting rates in September, the only question is how big the first cut will be.

I feel more confident in my predictions when politics override economics. This is because of Newtonian political physics – politicians in power want to stay in power. They will do whatever it takes, regardless of economic conditions, to get re-elected. This means that incumbent Democrats will use all monetary policy tools to keep the stock market rising until the November election, no matter what happens. The economy will not be short of cheap and plentiful fiat money.

The Impact of Yen Fluctuations

The exchange rates between currencies are primarily influenced by interest rate differentials and expectations of future interest rate changes.

The chart above shows the USD/JPY exchange rate (yellow) versus the USD-JPY interest rate differential (white). The interest rate differential is the Fed's effective funds rate minus the Bank of Japan's overnight deposit rate. When USD/JPY rises, the yen depreciates and the dollar appreciates; when it falls, the opposite is true. When the Fed began tightening monetary policy in March 2022, the yen depreciated sharply. The yen depreciated to its highest level ever in July, when the interest rate differential was at its widest.

The yen rebounded strongly after the Bank of Japan raised its policy rate from 0.10% to 0.25% in late July. The Bank of Japan made it clear that it would start raising rates at some point in the future. It is difficult for the market to predict when they will start raising rates. Like unstable snow layers, it is difficult to predict which snowflake or which turn on skis will trigger an avalanche. A 0.15% reduction in the interest rate differential should have been insignificant, but it was not. The trend of a strong rebound in the yen has begun, and the market is now highly focused on the future direction of the USD-JPY interest rate differential. As expected, the Japanese Yen has also found strong support following Powell’s policy shift as interest rate differentials are expected to narrow further.

This is the previous USD/JPY chart. I would like to re-emphasize that the Japanese Yen found strong support following Powell’s confirmation of the September rate cut.

The short-term boost from the Fed Funds rate cut could quickly wear off if traders resume unwinding USD-JPY carry trade positions as the value of the yen surges. More rate cuts in an effort to stem the decline in various financial markets would only accelerate the narrowing of the USD-JPY interest rate differential, which in turn would strengthen the Japanese Yen and lead to more positions being unwound. The market needs “real food” in the form of printed money provided by the rising Fed balance sheet to stem the losses.

If the yen appreciation accelerates, the first step will not be to resume the quantitative easing (QE) policy. The first step will be for the Fed to reinvest the cash from maturing bonds in US Treasuries and mortgage-backed securities. This will be seen as stopping its quantitative tightening (QT) program.

If the painful trend continues, the Fed may use central bank liquidity swaps and/or resume quantitative easing (QE) money printing. In this context, Yellen will increase US dollar liquidity by selling more Treasuries and reducing the fiscal account balance. Neither of these two market manipulators will use the destructive impact of the end of the yen carry trade on the market as a reason to resume aggressive money printing. It is not in line with American values to admit that other countries have any influence on this free and democratic country!

If the USD-JPY exchange rate quickly falls below 140, I believe they will not hesitate to provide the "real food" that the fiat currency financial markets need.

Trading Setups

In the final stages of the third quarter, fiat liquidity conditions could not be better. As crypto holders, we have the following tailwinds behind us:

1. Global central banks, especially the Fed, are reducing the cost of money. The Fed is still cutting rates when inflation is above its target, and the US economy continues to grow. The Bank of England (BOE) and the European Central Bank (ECB) may cut rates further at their upcoming meetings.

2. Bad girl Yellen promised to issue $271 billion in Treasury bills and conduct $30 billion in repo operations by the end of the year. This will inject $301 billion in liquidity into financial markets.

3. The US Treasury has about $740 billion left in the general account, which can and will be used to stimulate the market and help Harris win.

4. The Bank of Japan was extremely concerned about the pace of yen appreciation after its July 31, 2024 meeting, when it raised interest rates by 0.15%. As a result, it publicly stated that future rate hikes would take into account market conditions. This is a veiled way of saying "if we think the market will fall, we won't raise rates."

I'm in the crypto world; I don't follow stocks. So, I don't know if stocks will rise. Some people point to historical examples of stock markets falling when the Fed cuts rates. Some people worry that Fed rate cuts are a leading indicator of recession in the United States and developed markets. This may be true, but imagine what the Fed would do if it cut rates when inflation is above target and economic growth is strong. They will increase their money printing and significantly increase the money supply. This will lead to inflation, which can be bad for certain types of businesses. But for an asset like Bitcoin with a limited supply, it will make Bitcoin "to the moon."

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