Macro Analysis: Rate Regime Shift

It truly is a strange game the financial markets have to play, where analysts, traders, and bankers sit around waiting to lip-read the Federal Reserve announcements once a month to see what the central planners are going to do about interest rates.

Whilst I certainly spend a lot of time listening to, reading about, and studying Macro, I am not going to kid myself as a Fed tea leave reader. Instead, I tend to revert to the market, to see what big picture signals it is sending. Day to day price moves are kind of irrelevant in my framework. However big structural shifts are something I like to pay attention to.

I won’t attempt to explain too much of the nitty gritty of the relationship between the Fed, and the bond market, but suffice to say, The Fed is in a pretty tough spot right now:

- They for sure do not want inflation to come rip-roaring back, so they will be hesitant to lower interest rates…

- But at the same time, they for sure do not want to deal with a financial collapse in the credit markets.

The problem is that these Treasuries are owned by someone, and as rates rise, prices of the bonds fall. And as a result, there are a lot of entities out there, with hundreds of billions of dollars of unrealized loss. We also have an inverted yield curve which is not great for banks who are now unable to borrow short and lend long.

If all of the above is gibberish, lets get a chart out to highlight that SOMETHING has changed recently.

The chart below shows a colourful layout of various US Treasury bond yields compared to the Fed Funds rate (in white). Highlighted is the point back in Feb 2022 when the bond market started to clearly signal that interest rates were too low, and the Fed was behind the curve. As the bond market sold off (yields rising), it was signalling to old mate Jay Powell that they needed to hike in a hurry –> time to raise rates Jay!

Now something caught my eye today, and it was that since SVB collapsed, the bond market has started quite clearly signalling the inverse regime. Treasury rates from 1-month up to 30-years are all now trading at levels some distance below the Fed Funds rate. Only the longest duration 30-year Treasury is above, and only just.

We saw the first inversion start back in Nov 2022 when bonds in the range of 2-year up to the 10-year dropped below the Fed rate. Now this is in part the market signalling, but the market can of course be wrong at times.

However what really matters is that we now also have the shorter term rates < 1-year falling below, and holding there. I believe the market is now quite sure that the Fed has, or is very soon to break something. The market is now firmly signalling that rates are too high –> time to slow down Jay!

This to me feels like a major shift. I have no idea if Jay will pivot, pause, or panic, but my expectation is that things are about the shift gears in macro land. There are so many factors at play impacting this too:

- Rising geopolitical risk

- Elevated selling of treasuries from foreign reserves

- Increasing deficit spending (Treasury issuance) by the US Gov

- Banking crisis, real estate bubbles, bond market impairment, and collateral risk

- Inflation risk, which is heavily linked to tight energy markets, with OPEC also playing games with supply

The world is in a fairly precarious place right now, and given the shape of the yield curves above, my expectation is that we’re heading towards volatility. Lucky for us as Bitcoiners, we’re used to volatility. It is very hard to know what the near term implications of this are, but there are a few grounding anchors I am working off:

- I believe inflation will come back and is very sticky, in part a result of resource scarcity (energy and commodities likely to rise in price)

- I believe the Fed will hold/raise rates until something truly breaks to combat inflation and maintain their supposed credibility.

- When they break something, it will probably be nasty, and I’d expect everything to get caught up in the sell-off.

- The Fed is the ONLY buyer with a balance sheet large enough to buy these bonds –> they WILL print the money, this is mathematically guaranteed…eventually.

- I also expect the market to front run this reality, leading to an upwards net response for commodities, Gold, and BTC.

Whilst this is in no way financial advice (I have no idea what I am doing), I know sometimes it helps to know what other people are doing to prepare in this wacky world we are in. So a quick snapshot of how I am preparing for the years ahead, although the thesis really hasn’t changed much over the last 12 months:

- I’m a buy and hold guy, I don’t really trade much as it consumes too much time, emotion, and brain power.

- Bitcoin remains my #1 holding, and by some margin (TradFi analysts would cry…)

- I hold modest STX and small XMR bag, but hold no other altcoins (and will not be allocating any capital to them)

- I have a slightly larger cash balance than usual both for personal security, but also to take advantage of any chaos that may unfold

- I am fortunate to be an Aussie, and can take advantage of the plethora of quality commodity and energy related stonks on the ASX. I expect that commodities, energy, gold, and nuclear are going to perform well (simple logic: scarce unprintable resources, that society needs, in a world of infinite fiat).

A final note is that Gold is near (or at in AUD) all-time-highs, which I think really setting the tone for what is ahead. The whole periodic table of elements could be repriced higher in the years to come.