Crypto Market To React With Fed Meeting

This week, the annual Jackson Hole Economic Policy Symposium will be held from August 25-27 in Wyoming, US. The symposium draws participants from central bankers, finance ministers, policymakers, academics, and other financial market participants worldwide. Among the highlights of the symposium are the remarks from the Fed Chair, Jerome H Powell, on Friday, August 26, 2022. 

The financial markets will look for any cues from the Fed Chair’s remarks on controlling inflation and the upcoming benchmark interest rate announcement. The Fed uses the Jackson Hole symposiums to provide their outlook on the US and the global economy and to shed light on their monetary policy stance.

The major US stock indices have been down over the past five days, with the DJIA down 2.5%, the S&P 500 down 3.70%, and the Nasdaq Composite down 5.69%. The crypto markets are also down over the past five days, with the global crypto market cap falling about 12% around the US$ 1 trillion mark, as of press time. 

The 2021 Jackson Hole symposium theme was “Macroeconomic Policy in an Uneven Economy”. In his opening remarks under the title “Monetary Policy in the Time of COVID”, Powell said: “The rapid reopening of the economy has brought a sharp run-up in inflation. Over the 12 months through July, headline and core personal consumption expenditures inflation measures have run at 4.2% and 3.6%, respectively—well above our 2% longer-run objective.  Businesses and consumers widely report upward pressure on prices and wages. Inflation at these levels is, of course, a cause for concern. But that concern is tempered by several factors that suggest that these elevated readings are likely to prove temporary. This assessment is critical and ongoing, and we carefully monitor incoming data”.

To control rising inflation this year, the Fed raised its benchmark interest rate by 25 basis points in March 2022, followed by another 50 basis points hike in May 2022. June 2022 saw a 75 basis points interest rate hike, the most aggressive since 1994. This was followed by another 75 basis points interest rate hike in July 2022. The following Fed interest rate announcement is scheduled for September 21, 2022.

The Fed hasn’t really tightened financial conditions yet.  Over the past few years, inflation has gone up much more than the fed funds rate.  It is equally important that the Fed has not undone any of their manipulation of the government bond and mortgage markets. 

Real rates – the rate an investor receives after inflation – are near the worst they’ve ever been.

The obvious point is:  you can’t tame runaway inflation with fed funds 600 basis points LOWER than inflation.  The Fed will be forced to tighten much more than the markets currently forecast.

It was well over a year ago that real fed funds broke the negative all-time record set in February 1975.  In the 70’s, we had YoY inflation just a touch higher – at 11.2%, but the Fed was really fighting it – with fed funds at 6.24%.  So the real fed funds rate was -4.96%.

This Fed cruised right through that milestone.  Going all the way to -8.30% in March 2022 when they finally began removing that massively accommodative policy.  By the time they began tightening, YoY CPI was already 8.5%.  Unbelievable.

As the table below shows, we are still 7.77 percentage points below the 50-year average real fed funds rate.  Another 75 bps won’t do it.  The Fed will ultimately have to tighten several hundred basis points more.

I still believe that fed funds will not stop rising until they are at least 4-5%.

I love this line:

“The whole point of 75-basis-point increases is to tighten financial conditions.  Each time Jay Powell has raised rates, ironically, he has eased financial conditions because of his unwillingness to acknowledge the Fed is prepared to take the country into a recession in order to eliminate the inflation scourge.”

— Bill Ackman, Founder & CEO of Pershing Square Capital Management, Twitter, July 27, 2022

While is it now consensus that the Fed allowing inflation to get 830 bps above their overnight policy rate was a huge failure, few are addressing the equally important and continued policy error – pushing the long-term government and mortgage bond yields well below free-market levels.

As Bill Ackman said so well, the Chair of the Fed refuses to allow long rates to adjust to a fair-market level (much higher).  With this, the Fed is still providing massive stimulus to interest rate-sensitive sectors like housing and motor vehicles.

The real rate of return is the yield a bond investor receives after inflation.  For U.S. 10-year notes, the average real rate over the fifty years before Quantitative Easing (1957-2007) is +2.63%.

The Fed’s decision to print half of our country’s GDP and use it to push up the price of bonds has forced the real rate to negative 5.85%.

The gray area is our brave new world of unlimited bond purchases.  We are now an incredible 8(.)48 percentage points below average.

No economically-rational investor would buy something guaranteed to lose 585 bps every year.  That’s why the Fed bought bonds equivalent to 200% of all mortgage issuance in 2020 and 2021.  No rational actor would do that.

Let’s see what happens Friday.