In the final stages of the third quarter, the statutory liquidity conditions couldn't be better.

Author: Arthur Hayes

Translation: DeepTechFlow

(Any views expressed here are the personal views of the author and should not be used as a basis for investment decisions, nor should they be interpreted as advice to engage in investment transactions.)

I ended the 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 who haven't experienced this activity, the process involves attaching climbing skins to the bottom of skis so that you can ski uphill. Once at the top, you remove the skins and adjust your boots and skis to downhill mode to enjoy the abundant powder snow. Most of the mountains I visited could only be reached in this way.

A typical four to five-hour skiing day consists of 80% uphill skiing and 20% downhill skiing. Therefore, this activity requires a lot of energy. Your body burns calories to maintain body temperature and internal balance. Your legs, the largest muscle group in your body, are always working whether you're climbing or skiing downhill. My basal metabolic rate is about 3000 calories, and with the energy needed for leg movement, my total daily energy expenditure exceeds 4000 calories.

Because of the enormous energy required to complete this activity, the combination of food I consume throughout the day is crucial. I have a hearty breakfast in the morning, including carbohydrates, meat, and vegetables; I call it "real food." Breakfast makes me feel full, but as I enter the cold forest and start the initial ascent, these initial energy reserves are quickly depleted. To manage my blood sugar levels, I prepare snacks that I don't usually eat, just like Su Zhu and Kylie Davies avoiding the liquidator appointed by the BVI bankruptcy court. I eat a Snickers bar and syrup every 30 minutes on average, even when 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 meet my energy needs. I also need to consume "real food." After completing a lap, I usually stop for a few minutes, open my backpack, and eat the food I've prepared for myself. I prefer Tupperware containers with chicken or beef, stir-fried leafy vegetables, and plenty of white rice.

I pair periodic sugar peaks with longer-burning, clean "real food" to sustain my performance throughout the day.

I describe the pre-skiing trip meal preparation to lead into a discussion about the relative importance of currency prices and quantities. For me, the price of currency is like the Snickers bar and syrup I eat, providing me with a quick glucose boost. The quantity of currency is like the slow, sustained burn of "real food." At last week's Jackson Hole central bank meeting, Powell announced a policy shift, with the Fed finally committing to lower policy rates. In addition, officials from the Bank of England (BOE) and the European Central Bank (ECB) also indicated that they would continue to lower policy rates.

Powell announced this shift at around 9 a.m. GMT-6, corresponding to the red ellipse. Risk assets represented by the S&P 500 index (white), gold (yellow), and Bitcoin (green) all rose as currency prices fell. The dollar (not shown) also weakened over the weekend.

The initial positive market reaction is reasonable, as investors believe that if currencies become cheaper, assets priced in fixed-supply fiat currencies should rise. I agree with this view; however… we forget that the expected rate cuts by the Fed, BOE, and ECB will reduce the interest rate differentials between these currencies and the yen. The risk of yen carry trades will reemerge and could spoil the party unless in the form of central bank balance sheet expansion, i.e., printing money, increasing the quantity of currency.

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

The dollar strengthened against the yen by 1.44%, and immediately after Powell announced the policy shift, USDJPY fell. This was expected, as the expected interest rate differential between the dollar and the yen will narrow due to the decrease in dollar rates and the yen rates remaining steady or rising.

The rest of this article aims to delve into this point and look ahead to key moments in the coming months before indifferent American voters elect Trump or Biden.

Premises of the Bull Market Argument

As we observed in August of this year, the rapid appreciation of the yen poses a danger to the global financial markets. If rate cuts in the three major economies lead to the yen appreciating against their domestic currencies, we should expect negative market reactions. We are faced with a struggle between positive (rate cuts) and negative (yen appreciation) forces. Considering that the total value of global financial assets financed in yen exceeds trillions of dollars, I believe that the negative market reaction from yen carry trades caused by rapid yen appreciation will outweigh any benefits gained from minor rate cuts in dollars, pounds, or euros. Furthermore, I believe that decision-makers at the Fed, BOE, and ECB are aware that they must be willing to ease policy and expand their balance sheets to counter the adverse effects of yen appreciation.

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

Since 2020, the manipulated U.S. Consumer Price Index (white) has risen by 22%. The Fed's balance sheet (yellow) has increased by over $3 trillion.

The U.S. government's deficit has reached record levels, partly because the cost of issuing debt has not been restricted enough to force politicians to raise taxes or reduce subsidies to balance the budget.

If the Fed truly wants to maintain confidence in the dollar, it should raise rates to curb economic activity. This will result in lower prices for everyone, but some people will lose their jobs. At the same time, it will also control government borrowing, as the cost of issuing debt will rise.

The U.S. economy has only experienced two quarters of actual GDP contraction after COVID. This is not an economy that is weak and in need of rate cuts.

Even the recent estimate for actual GDP in the third quarter of 2024 has reached +2.0%. Once again, this is not an economy overly constrained by restrictive interest rates.

Just as I eat candy and syrup when I'm not hungry to prevent my blood sugar levels from dropping, the Fed promises to never let the financial markets stagnate. The United States is a highly financialized economy that requires continuously rising asset prices to make people feel prosperous. In practical terms, stock performance remains flat or declines, but most people don't pay attention to their actual returns. Stocks that rise nominally also increase capital gains tax revenue in fiat currency terms. In short, a market downturn is detrimental to the financial health of Pax Americana. Therefore, Yellen began interfering with the Fed's rate hike cycle in September 2022. I believe that Powell, under the direction of Yellen and Democratic leaders, is sacrificing himself by choosing to cut rates when he knows he shouldn't.

I present the chart below to illustrate what happened to stocks when the U.S. Treasury, under Yellen's control, began issuing large amounts of Treasury bills, drawing funds from the Fed's reverse repurchase agreement (RRP) program, and flowing into the broader financial markets.

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

All prices are benchmarked to 100 on September 30, 2022; this was the peak of the RRP, at around $2.5 trillion. The RRP (green) decreased by 87%. The nominal fiat dollar return of the S&P 500 index (gold) increased by 57%. I believe that the power of the U.S. Treasury exceeds that of the Fed. The Fed had been raising currency prices until March 2023, but the Treasury found a way to increase currency quantities at the same time. The result is a nominal stock market boom. When priced in gold, the oldest form of real money (other forms being fiat currency), the S&P 500 index (white) only increased by 4%. When priced in Bitcoin, the most robust emerging form of money, the S&P 500 index (magenta) fell by 52%.

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

Before discussing the impact of yen appreciation, I want to quickly talk about the false reasons for Powell's rate cut and how this further strengthens my confidence in the rise of risk asset prices.

Powell made adjustments based on a poor employment report. The U.S. President Biden's Bureau of Labor Statistics (BLS) made a shocking revision to previous employment data, indicating an overestimation of employment by about 800,000, just days before Powell's speech at Jackson Hole.

Biden and his dishonest economic supporters have been claiming a strong labor market during his presidency. This strong labor market put Powell in a dilemma, as high-ranking Democratic senators, such as Elizabeth "Pocahontas" Warren, called for rate cuts to stimulate the economy so that Trump wouldn't win the election. Powell was in a dilemma. Due to inflation exceeding the Fed's 2% target, Powell couldn't cut rates due to a decrease in inflation. He also couldn't cut rates due to a weak labor market. But let's sprinkle a little political smoke in this situation and see if we can help our "beta cuck towel bitch boy."

Biden behaved like a medicated vegetable in the debate with Trump, and was subsequently abandoned by the Obamas. He was replaced by Kamala Harris, who, if you believe mainstream media reports, had nothing to do with any policies implemented by the Biden/Harris administration over the past four years. A magical political move.

Powell could have used this opportunity to blame rate cuts on a weak labor market, but he didn't. Now he has announced that the Fed will cut rates in September, the only question is the extent of the first rate cut.

When politics overrides economics, I am more confident in my predictions. This is because of Newtonian political physics—ruling politicians want to maintain power. They will do whatever it takes, regardless of economic conditions, to win re-election. This means that the current Democrats will use all monetary policy tools to maintain the stock market's rise before the November election. The economy will not lack cheap and abundant fiat currency.

Impact of Yen Volatility

Exchange rates between currencies are mainly influenced by interest rate differentials and expectations of future interest rate changes.

The chart above shows the USD/JPY exchange rate (yellow) compared to the USD-JPY interest rate differential (white). The interest rate differential is the effective federal 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. The yen depreciated significantly when the Fed began tightening monetary policy in March 2022. In July of this year, the yen depreciation reached a historical high, at which point the interest rate differential was at its widest.

After the Bank of Japan raised the policy rate from 0.10% to 0.25% at the end of July, the yen rebounded strongly. The Bank of Japan explicitly stated that they would begin raising rates at some point in the future. The market finds it difficult to predict when they will start raising rates. Just like an unstable snow layer, it's difficult to predict which snowflake or which turn in skiing will trigger an avalanche. A 0.15% interest rate differential reduction should have been inconsequential, but it wasn't. The trend of a strong yen rebound has begun, and the market is now highly focused on the future trend of the USD-JPY interest rate differential. As expected, after Powell's policy shift, the yen also received strong support as the interest rate differential is expected to further narrow.

This is the previous USD/JPY chart. I want to emphasize once again that the yen received strong support after Powell confirmed the rate cut in September.

If traders unwind their USD-JPY carry trade positions when the value of the yen soars, the short-term stimulus from the Fed rate cut may quickly disappear. Taking further rate cuts to prevent various financial market declines will only accelerate the narrowing of the USD-JPY interest rate differential, which in turn will strengthen the yen and lead to more positions being unwound. The market needs "real food" in the form of printed currency from the continuously rising Fed balance sheet to stem the losses.

If the yen accelerates in value, the first step will not be to reinstate quantitative easing (QE) policy. The first step will be for the Fed to reinvest cash from maturing bonds into U.S. Treasuries and mortgage-backed securities. This will be seen as halting their quantitative tightening (QT) program.

If the painful trend continues, the Fed may use central bank liquidity swaps and/or reinstate quantitative easing (QE) money printing. In this context, Yellen will increase dollar liquidity by selling more government bonds and reducing the fiscal account balance. Neither of these market manipulators will use the end of the yen carry trade as a reason to restore aggressive money printing. Acknowledging any influence from other countries on this free and democratic country does not align with American values!

Trade Setup

In the final stages of the third quarter, the statutory liquidity conditions couldn't be better. As a cryptocurrency holder, we have the following tailwinds behind us:

1. Global central banks, especially the Federal Reserve, are lowering the cost of funds. The Federal Reserve is cutting interest rates even as inflation exceeds its target, while the U.S. economy continues to grow. The Bank of England (BOE) and the European Central Bank (ECB) may further cut interest rates at their upcoming meetings.

2. Bad girl Yellen has pledged to issue $271 billion in Treasury bills and conduct $300 billion in repurchase operations before the end of the year. This will inject $301 billion of liquidity into the financial markets.

3. The U.S. Treasury has approximately $740 billion in its general account, which can and will be used to stimulate the market and boost Harris's chances of winning.

4. The Bank of Japan expressed extreme concern about the speed of the yen's appreciation after its meeting on July 31, 2024, when it raised interest rates by 0.15%. Therefore, it publicly stated that future rate hikes will consider market conditions. This is a subtle way of saying, "If we think the market will decline, we won't raise rates."

I am from the cryptocurrency circle; I don't pay attention to stocks. So, I don't know if stocks will rise. Some people point out historical examples of stock market declines when the Federal Reserve cuts interest rates. Some are concerned that a Fed rate cut is a leading indicator of a recession in the U.S. and other developed markets. This may be true, but imagine if the Fed cuts rates when inflation is above target and the economy is strong. They will increase money printing significantly, leading to a significant increase in the money supply. This will cause inflation, which may be unfavorable for certain types of businesses. But for assets with limited supply like Bitcoin, it will send Bitcoin "to the moon."

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