Doc's Daily Commentary

Mind Of Mav

A New Fed Policy Could Be A Game-Changer For Bitcoin

Sometimes, market-moving developments arrive with a bang: A flash-crash, a major earnings report, a ground-shaking geopolitical development.

But sometimes, market-moving developments arrive slower: A change in policy that barely ripples the 24-hour news cycle but grows over time to be truly significant.

As an investor, there’s not much to gain from the louder news; it is processed and internalized by everyone simultaneously. But sometimes, the ripples can be overlooked, and that creates interesting avenues to explore.

We got one such ripple on August 27, when Federal Reserve Chair Jerome Powell’s gave an important speech to the Jackson Hole Economic Policy Symposium outlining a subtle but deeply significant shift of Fed policy.  The long-term implications for bitcoin are significant.

At the heart of the new policy framework is a significantly more accommodative and flexible approach to managing inflation. The shift is packaged into a small semantic change with big implications.

What’s The Change Entail?

Until Powell’s speech, Fed policy aimed to keep inflation trending toward 2% every year. Now, the Fed will aim to average 2% inflation over time, with the flexibility to go well above or below that number in any one year.

The chart below, which compares the Fed’s preferred inflation gauge, the core PCE index, with the 2% level, shows how much heavy lifting may be required. The core PCE came in at nearly 1.55% in September.

“Since the Great Recession of 2008-2009, there have been only two brief periods when the preferred inflation rate has exceeded the 2% target,” the St. Louis Fed wrote on its FRED blog last month. “In the past, the Federal Reserve has rarely tolerated rates above 2% and has raised interest rates whenever approaching the target. This new policy suggests that, if inflation can return to a range above 2%, the Federal Reserve will have to tolerate higher inflation than it has for much of the past 20 years—and tolerate it for significantly longer periods. Yet, given the pandemic, it could be challenging at this time to sustain average inflation above 2%.”

That may sound like a modest change, but in the world of Fed policy, it’s massive. It means that if inflation runs below 2% for a number of years, the Fed will let it run at higher levels for a period of time to catch up. There is no explicit formula around how the average inflation rate will be calculated, giving the Fed new flexibility to adjust to inflationary results by feel, both to achieve its inflation target and to achieve its macroeconomic goals.

CNBC captured the zeitgeist of the moment in its preview of Powell’s speech:

History will remember Paul Volcker and Jerome Powell as standing on the opposite ends of the inflation canyon, with the former taking desperate actions to try to tamp it down and the latter … (making) an unprecedented effort to crank it back up.

What does this mean for investors?

One of the best pieces of investment advice is Marty Zweig’s age-old quip: “Don’t fight the Fed.” In this case, if the Fed is willing to go to any length to see inflation printing higher, it is fair to assume it will eventually get its way … and perhaps more than it bargains for. Reflecting on the new policy, legendary investor Stanley Druckenmiller predicted we could easily see inflation between 5% and 10% over the next four or five years. Others— including Former Fed Chair Alan Greenspan, Ray Dalio, and Paul Tudor Jones—are concerned about inflation as well.

Investors Are Racing For Bitcoin

When investors worry about inflation and want to position accordingly, the traditional safe haven is of course gold. Indeed, investors have allocated more than $29 billion to gold ETFs alone so far this year.

As investors become increasingly queasy about a more inflation-tolerant Federal Reserve, one of the biggest potential winners is bitcoin.

If an investor was seeking to put all their money in one asset, features like volatility and high betas might not sound appealing. But in the context of trying to hedge their portfolio, those features mean you get a lot of bang for your buck. A very small allocation of bitcoin, even 1%, can have a huge impact.

This year, amid incredible turmoil in markets and uncertainty. It’s only one year of course, but as many reports have shown, the multi-year performance is impressive as well.

Bitcoin’s nascency means it’s not something everyone agrees on, and conveys a lot of risks. But it also means that bitcoin still has a lot of room to run, which makes it potent. And of course, there’s a growing crowd who believes that a digital version of gold—with its resistance to being seized, ease of transfer, ease of storage, always-open markets, and privacy—is a big part of the future.

Jerome Powell’s landmark new inflation policy is causing many investors right now to consider their positioning if inflation comes to pass. When we look at the available options to hedge this exposure, bitcoin shows increasingly well.

As Paul Tudor Jones recently wrote about his fund’s allocation to bitcoin, “I am not a hard-money nor a crypto nut. I am not a Millennial … but a Baby Boomer who wants to capture the opportunity set while protecting my capital in ever-changing environments.”

Now increasingly seems to be the right place and right time for bitcoin.

 

 

 

 

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