Yellen or talkin -- Arthur Hayes
inflation resurges? but it doesn't matter? hmm
Arthur gives us a refresher on how we got here, where we are, and lays out the bear case in more detail. I split this into several sections:
How we got here (+ charts)
Where we are
Inflation resurgence?
Arthur’s trade plan
How we got here
The Fed shifted their stance substantially over the last 3 months
On Nov 1, Yellen enticed MMFs to rotate $ from the reverse repo program into higher yielding T-bills (indirectly injecting more liquidity into the market)
In mid Dec, Powell hinted at potential rate cuts in 2024. Just 2 weeks ago he mentioned that the Fed would continue holding rates to ensure inflation doesn’t return
As a result SPX and NDX both hit new ATHs
However post ETF approval BTC retraced from 48 to sub 40 (despite 820M of net new inflows). We also saw the 2Y treasury yield hit a local low of 4.14%
Arthur think these are two of the signals in that we should yield caution
The other big overhang is the bank term funding program (BTFP) - this was an emergency program that allowed the banks to borrow from the Fed at a 5% rate for the year in order to stay solvent.
Once BTFP ends, what will be the situation with bank solvency?
Arthur’s stance is that the BTFP won’t be renewed, resulting in significant volatility
Charts
RRP + TGA are isolated (outside the financial system), so as this goes up, this represents more $ flowing into the financial system
White is the regional banking ETF in white and yellow is the 2Y treasury yield Higher yield negatively correlates with liquidity (and banking ETF prices)
1st crisis was the banking failures (higher yields also means balance sheet of these banks are wrecked as they all aped into super long term treasuries when yields were at the bottom)
2nd crisis occurred when the market realized the increasing US deficit meant that an insane amount of bonds needed to be issued to finance it
So long term rates rose, resulting in a bear steepener (wrecking banks balance sheets even more) - more details here
Where we are
As the RRP slowly gets closer and closer to zero, the market wonders what is next
KRE (regional banking ETF) continues rising even though 2Y yields are continuing to climb higher
Arthur thinks BTC tells the real story - that the Fed is trapped between inflation and a banking crisis
He also thinks the Fed will try to talk everyone into believing banks are sound
Given SPX is at ATHs + risk free rate is at 5% the US is doing quite well
The Atlanta Fed also estimates Q4 ‘23 GDP growth at 2.4% which is quite strong
However, the average American is broke and in debt
“The top 10% holds ~65% of all financial assets but only ~8% of the debt. The bottom 90% holds 92% of the debt but only 35% of the assets”
2024 is election year, and as we know, a strong economy means better chance to be elected
As a result, Yellen needs the stock market to pump
But Powell needs inflation to be at a reasonable level
The issue around inflation is that it is affected by externalities that the US has no controls over (e.g. geopolitical issues)
Something that is unfolding is the supply chain crisis – difficult in shipping goods
Inflation resurgence?
Because of el Nino weather - this has caused a drought in the canal which means fewer ships can transit it
The alternate route, the Bab el-Mandeb, is unavailable. This is because the Houthis will fire drones at Western merchant ships
The Houthis think the Gaza war is a genocidal exercise, and therefore they will send out drones to attack merchant ships if they go through the Bab el-Mandeb. To nullify this drone, the US must launch a missile that costs 2.1M whereas the drone costs $2000
There is significant pressure on the US as the peacemaker
Western ships must now sail around the cape of good hope - this rerouting affects 20-30% of all shipping and adds time + expense
A mild el Nino will typically last 1-2Y, but this one is even more severe
Ultimate result? Higher shipping costs
Arthur thinks this results in a resurge of inflation in Q3 - Q4 (inflation lags)
In combination with rate cuts and QE, inflation can be more super charged
So what would be an excusable reason to ignore the surge? A financial crisis..
“That is why, to get the cuts, QT taper, and the possible resumption of QE the market believes is already in the bag come March, we first need a few banks to fail when the BTFP is not renewed.”
Tactical trading
Arthur thinks BTC draws down further and holds 30-35k
He bought March 29 35k puts and dumped his Sol and Bonk for a slight loss
Arthur thinks that because crypto is the last freely traded global market, they will anticipate changes in dollar liquidity before the tradfi markets do
Arthur also thinks BTFP won’t be renewed as it hasn’t been mentioned once - and if it expires, where will the banks find the extra 200B to pay back?
HIs invalidation is that if it is extended, then we resume up only
Otherwise, he will bid hard once BTC drops 35k
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Love these summaries!