Arthur Hayes's new article: The Federal Reserve's interest rate cuts and the strengthening of the yen will send Bitcoin "To The Moon."

Author: Arthur Hayes

Compiled by: Shenchao TechFlow

(Any opinions expressed here are solely those of the author and should not be construed as investment advice or recommendations to engage in investment transactions.)

I have finished my summer vacation in the Northern Hemisphere and have moved to the Southern Hemisphere to ski for two weeks. Most of my time was spent on backcountry skiing trips. For those friends who have not experienced this activity, the process involves attaching climbing skins to the bottom of your skis so you can ski uphill. Once you reach the top, you remove the skins, adjust your boots and skis to downhill mode, and enjoy the abundant powder snow. The mountain I went to can mostly only be accessed this way.

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

Due to 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 that includes carbohydrates, meats, and vegetables; I call it "real food." The breakfast keeps me feeling full, but as I enter the cold forest and begin the initial ascent, those initial energy reserves are quickly depleted. To manage my blood sugar levels, I prepare some snacks that I usually don't eat, just like Su Zhu and Kylie Davies avoid the liquidators appointed by the BVI bankruptcy court. I eat a Snickers bar and syrup every 30 minutes on average, even if I am not hungry. I do not want my blood sugar levels to drop too low, which would 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 each lap, I usually stop for a few minutes, open my backpack, and eat the food I prepared myself. I prefer containers with chicken or beef, sautéed leafy greens, and plenty of white rice.

I pair periodic sugar spikes with the intake of longer-burning, clean real food to maintain my performance throughout the day.

The purpose of describing the meal preparation for my skiing trips is to lead into a discussion about the relative importance of the price and quantity of money. For me, the price of money is like the Snickers bars and syrup I eat, providing a quick glucose boost. The quantity of money is like the slow, sustained-burning "real food." At last Friday's Jackson Hole central bank meeting, Powell announced a policy shift, and the Federal Reserve (Fed) finally committed to lowering policy interest rates. Additionally, officials from the Bank of England (BOE) and the European Central Bank (ECB) also indicated that they would continue to lower policy interest rates.

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

The initial positive reaction from the market is reasonable, as investors believe that if money becomes cheap, assets priced in fixed-supply fiat currency should rise. I agree with this view; however… we forget that the anticipated rate cuts from the Fed, BOE, and ECB will reduce the interest rate differentials between these currencies and the yen. The risks of yen carry trades will re-emerge and could spoil the party unless the quantity of money is increased in the form of central bank balance sheet expansion, that is, printing money.

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

The dollar strengthened against the yen by 1.44%, but immediately after Powell announced the policy shift, USDJPY fell. This was expected, as the anticipated interest rate differential between the dollar and yen is expected to narrow due to declining dollar rates and stable or rising yen rates.

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

Premise of the Bullish Argument

As we observed in August this year, the rapidly appreciating yen poses a danger to global financial markets. If the rate cuts from the three major economies lead to an appreciation of the yen against their domestic currencies, we should expect a negative market reaction. We are facing a battle between positive (rate cuts) and negative (yen appreciation) forces. Considering that the total amount of global financial assets financed in yen exceeds tens of trillions of dollars, I believe the negative market reaction from yen carry trades due to the rapid appreciation of the yen will outweigh any benefits gained from minor rate cuts in the dollar, pound, or euro. Furthermore, I believe that the decision-makers at the Fed, BOE, and ECB realize they must be willing to ease policy and expand their balance sheets to offset the adverse effects of yen appreciation.

Consistent with my skiing metaphor, the Fed is trying to get a "sugar spike" from rate cuts before hunger sets in. From an economic perspective, the Fed should raise interest rates instead of lowering 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 constrained enough to force politicians to raise taxes or cut subsidies to balance the budget.

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

The U.S. economy has only experienced two quarters of actual GDP contraction since COVID. This is not a weak economy that needs rate cuts.

Even recent estimates for actual GDP in Q3 2024 have reached +2.0%. Once again, this is not an economy affected by overly restrictive rates.

Just as I eat candy and syrup when I am not hungry to prevent 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 requires continuously rising prices of fiat assets to make the public feel wealthy. In real terms, stock performance is flat or declining, but most people do not care about their real returns. Nominally rising stocks also increase capital gains tax revenue in fiat currency. In short, a market downturn is detrimental to the financial health of Pax Americana. Therefore, Yellen began to interfere with the Fed's rate hike cycle in September 2022. I believe 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 a large number of Treasury bills (T-bills), drawing funds out of the Fed's reverse repo program (RRP) and into the broader financial markets.

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

All prices are indexed to 100 as of September 30, 2022; this was the peak of the RRP, around $2.5 trillion. The RRP (green) fell by 87%. The nominal fiat dollar returns of the S&P 500 index (gold) rose by 57%. I believe the power of the U.S. Treasury exceeds that of the Fed. The Fed had been raising the price of money until March 2023, but the Treasury found a way to simultaneously increase the quantity of money. The result was a nominal stock market boom. When priced in gold, the oldest form of real money (other forms are credit money), the S&P 500 index (white) only rose by 4%. When priced in Bitcoin, this emerging and most robust form of money, the S&P 500 index (magenta) fell by 52%.

The U.S. economy does not crave rate cuts, but Powell will provide sugar stimulus. Because the monetary authorities are extremely sensitive to any decline in the prices of fiat stocks, Powell and Yellen will soon provide "real food" in some form, namely expanding the Fed's balance sheet to offset the effects of yen appreciation.

Before discussing yen appreciation, I want to briefly talk about Powell's false reasons for lowering rates and how this further strengthens my confidence in rising prices of risk assets.

Powell adjusted based on a poor employment report. The U.S. Department of Labor (BLS), under President Biden, released a shocking revision of previous employment data just days before Powell's speech at Jackson Hole, indicating that employment estimates were overstated by about 800,000.

Biden and his dishonest economist supporters have been claiming a strong labor market during his administration. This strong labor market puts Powell in a dilemma, as senior Democratic senators, like Elizabeth "Pocahontas" Warren, are calling for him to cut rates to stimulate the economy so that Trump does not win the election. Powell is in a bind. With inflation exceeding the Fed's 2% target, Powell cannot cut rates due to falling inflation. He also cannot cut rates citing a weak labor market. But let’s sprinkle a little political misdirection in this situation and see if we can help our "beta cuck towel bitch boy" (Note: This term is used to describe someone perceived as weak, lacking masculinity, and easily controlled by others).

Biden performed like a prescription-drugged vegetable in the debate against Trump, thus being abandoned by the Obamas. He was succeeded by Kamala Harris, who, if you believe mainstream media reports, has nothing to do with any policies implemented by the Biden/Harris administration over the past four years. Therefore, the Bureau of Labor Statistics can acknowledge their mistakes without affecting Harris, as she has never truly been involved in the government she serves as vice president. Such a magical political sleight of hand.

Powell could have used this opportunity to blame rate cuts on a weak labor market, but he did not take that chance. Now he announces that the Fed will start cutting rates in September, and 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 Newton's political physics—politicians in power want to maintain their power. They will do whatever it takes, regardless of economic conditions, to secure re-election. This means that, no matter what happens, the incumbent Democrats will use all monetary policy tools to keep the stock market rising before the November elections. The economy will not lack cheap and abundant fiat money.

Impact of Yen Volatility

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

The chart above shows the comparison of the USD/JPY exchange rate (yellow) with 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 the USD/JPY rises, the yen depreciates, and the dollar appreciates; when it falls, the opposite occurs. The yen depreciated significantly when the Fed began tightening monetary policy in March 2022. In July of this year, the yen's depreciation reached a historic high when the interest rate differential was at its widest.

After the Bank of Japan raised its policy rate from 0.10% to 0.25% at the end of July, the yen made a strong comeback. The Bank of Japan has clearly stated that it will begin raising rates at some point in the future. The market finds it difficult to predict when they will start raising rates. Like unstable snow layers, it is hard to predict which snowflake or ski turn will trigger an avalanche. A 0.15% reduction in the interest rate differential should have been inconsequential, but that is not the case. The trend of the yen's strong rebound has begun, and the market is now highly focused on the future trajectory of the USD-JPY interest rate differential. As expected, after Powell's policy shift, the yen received strong support as the interest rate differential is expected to narrow further.

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

If traders unwind their USD-JPY carry trade positions as the yen's value soars, the short-term stimulus from the Fed's rate cuts may quickly dissipate. Taking further rate cut measures to prevent declines in various financial markets 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," provided in the form of printed money by the continuously rising Fed balance sheet, to stop the losses.

If the yen appreciates rapidly, the first step will not be to restore quantitative easing (QE) policies. 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 a halt to its quantitative tightening (QT) plan.

If the painful trend continues, the Fed may resort to central bank liquidity swaps and/or restore quantitative easing (QE) to print money. In this context, Yellen will increase dollar liquidity by selling more Treasuries and reducing the balance in the Treasury account. These two market manipulators will not use the destructive impact of the end of yen carry trades as a reason to restore aggressive money printing. Acknowledging any influence from other countries on this free and democratic nation does not align with American values!

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 Setup

In the final phase of Q3, the conditions for fiat liquidity could not be better. As cryptocurrency holders, we have the following tailwinds behind us:

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

2. Bad girl Yellen has committed to issuing $271 billion in Treasury bills before the end of the year and conducting $30 billion in repurchase operations. This will inject $301 billion in liquidity into the financial markets.

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

4. The Bank of Japan is extremely concerned about the speed of yen appreciation after its meeting on July 31, 2024, when it raised rates by 0.15%. Therefore, it has 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 will not raise rates."

I am a person from the crypto space; I do not focus on stocks. So, I do not know if stocks will rise. Some people point to historical examples where the stock market fell when the Fed cut rates. Some are concerned that the Fed's rate cuts are a leading indicator of recession in the U.S. and developed markets. This may be correct, but consider what measures the Fed would take if it cuts rates while inflation is above target and the economy is growing strongly. They will increase money printing significantly, greatly expanding the money supply. This will lead to inflation, which may be detrimental to certain types of businesses. But for assets with limited supply like Bitcoin, it will send Bitcoin "to the moon."