The Fed's interest rate cut and the strengthening of the yen may drive Bitcoin back into a bull run

I just finished my summer vacation in the Northern Hemisphere and headed to the Southern Hemisphere to ski for two weeks. Most of the time was spent on backcountry skiing trips. For friends who haven't experienced it, the process involves attaching climbing skins to the bottom of the skis, allowing you to glide uphill. Once you reach the top, you remove the climbing skins, adjust the 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 skiing day consists of 80% uphill skiing and 20% downhill skiing. Therefore, this activity consumes a lot of energy. The body burns calories to maintain body temperature and internal balance. The legs are the largest muscle group in the body, constantly working whether climbing or skiing downhill. My basal metabolic rate is about 3000 kcal, and with the energy required for leg movements, the total energy expenditure exceeds 4000 kcal daily.

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, including 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 uphill, these initial energy reserves are quickly depleted. To manage my blood sugar levels, I prepare some snacks that I usually don’t eat. I have a Snickers and syrup every 30 minutes on average, even if I'm not hungry. I don’t want my blood sugar levels to drop too low, which would affect my performance.

Eating processed foods high in sugar is not a long-term solution to meet my energy needs. I also need to consume "real food." After completing a 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, stir-fried leafy greens, and a large amount of white rice.

I pair periodic sugar peaks with the intake of cleaner, real foods that burn for a longer time to maintain my performance throughout the day.

My purpose in describing the pre-dinner preparations for a ski trip is to introduce a discussion about the relative importance of currency price and quantity. To me, the price of currency is like the Snickers and syrup I eat, providing a quick boost of glucose. The quantity of currency, on the other hand, is like the "real food" that burns slowly and lasts longer. At last Friday's Jackson Hole central banking conference, Powell announced a shift in policy, and the Fed finally committed to lowering policy rates. In addition, officials from the Bank of England and the European Central Bank also stated that they would continue to lower policy rates.

Powell announced this shift around 9 a.m. local time. Risk assets represented by the S&P 500 index, gold, and Bitcoin all rose as currency prices fell. The dollar also weakened over the weekend.

The initial positive response from the market is reasonable, as investors believe that if the currency becomes cheaper, assets priced in fixed-supply fiat currencies should rise. I agree with this view; however... we have forgotten that the expected rate cuts from the Fed, Bank of England, and European Central Bank will reduce the interest rate differential between these currencies and the yen. The risks of yen carry trades will re-emerge and could spoil this party unless the quantity of money is increased in the form of central bank balance sheet expansion, that is, printing money.

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

The remainder of this article aims to delve into this issue and look ahead to the key moments in the coming months before American voters elect a new president.

Premise of the Bull Run Argument

As we observed in August of this year, the rapidly appreciating yen poses a danger to the global financial markets. If the interest rate cuts by the three major economies lead to an appreciation of the yen against their domestic currencies, then we should expect a negative reaction from the market. We are facing a battle between the positive ( interest rate cuts ) and the negative ( yen appreciation ) forces. Given that the total amount of global financial assets financed in yen exceeds several trillion dollars, I believe that the negative market reaction caused by yen arbitrage trading resulting from the rapidly appreciating yen will outweigh any benefits gained from minor interest rate cuts in the dollar, pound, or euro. Furthermore, I believe that the policymakers of the Fed, the Bank of England, and the European Central Bank realize that 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 the "sugar high" from rate cuts before hunger arrives. From an economic perspective, the Fed should raise interest rates, not cut them.

Since 2020, the manipulated US Consumer Price Index has risen by 22%. The Fed's balance sheet 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 yet been constrained enough to force politicians to raise taxes or reduce subsidies to balance the budget.

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

The US economy only experienced two quarters of real GDP contraction after the COVID-19 pandemic. This is not a weak economy that requires interest rate cuts.

Even the recent estimate for the actual GDP in the third quarter of 2024 has reached +2.0%. Once again, this is not an economy affected by excessively restrictive interest rates.

Just as I eat candy and syrup when I'm not hungry to prevent my blood sugar levels from dropping, the Fed promises to never let the financial markets stagnate. The United States is a highly financialized economy that requires continuously rising prices of fiat assets to make the public feel wealthy. On a practical level, stock performance is flat or declining, but most people do not pay attention to their real returns. Nominally rising stocks also increase capital gains tax revenue in fiat currency. In short, a market downturn is harmful to the financial health of the United States. Therefore, Yellen began to interfere with the Fed's interest rate hike cycle in September 2022. I believe that Powell, under the direction of Yellen and Democratic leaders, is sacrificing himself by choosing to cut interest 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 large amounts of treasury bonds, withdrawing funds from the Fed's reverse repo program, and flowing into the broader financial markets.

All prices are based on a benchmark of 100 as of September 30, 2022; this was the peak of the RRP at about $2.5 trillion. The RRP has decreased by 87%. The nominal USD returns of the S&P 500 index have increased by 57%. I believe that the power of the U.S. Treasury exceeds that of the Fed. The Fed was raising the cost of money until March 2023, but the Treasury found ways to simultaneously increase the supply of money. The result has been a nominal boom in the stock market. When priced in gold, gold is the oldest form of real currency ( while other forms are fiat currency ), the S&P 500 index has only risen by 4%. When priced in Bitcoin, this emerging and strongest form of currency, the S&P 500 index has fallen by 52%.

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

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

Powell made adjustments based on a dismal employment report. The U.S. Department of Labor released a shocking revision to previous employment data just days before Powell's speech in Jackson Hole, indicating that the employment estimate was over by about 800,000.

The current government and its dishonest economist supporters have been claiming that the labor market has been strong during his administration. This strong labor market puts Powell in a dilemma, as senior Democratic senators are calling for interest rate cuts to stimulate the economy in order to win in the elections. Powell is in a bind. With inflation exceeding the Fed's 2% target, Powell cannot lower interest rates due to a decline in inflation. He also cannot lower rates citing a weak labor market. But let's sprinkle a bit of political misdirection in this situation and see if we can help Powell.

The Bureau of Labor Statistics can acknowledge their mistakes without affecting the current government, as the vice president has never truly participated in the government during her tenure as vice president. Such a magical political trick.

Powell could have used this opportunity to blame the weak labor market for the rate cuts, but he did not take advantage of this chance. Now he announces that the Fed will start cutting interest rates in September, and the only question is the extent of the first rate cut.

When politics supersedes the economy, I am more confident in my predictions. This is because the politicians in power want to maintain their authority. They will do whatever it takes, regardless of economic conditions, to secure re-election. This means that, no matter what happens, the current government will use all monetary policy tools to sustain the stock market rise before the elections in November. The economy will not lack cheap and ample fiat currency.

The Impact of Yen Fluctuations

The exchange rates between currencies are mainly influenced by interest rate differentials and expectations of future interest rate changes.

The chart above shows the comparison between the USD/JPY exchange rate and the USD-JPY interest rate differential. The interest rate differential is the effective federal funds rate set by the Fed minus the overnight deposit rate of the Bank of Japan. When the USD/JPY rises, the yen depreciates and the dollar appreciates; when it falls, the opposite occurs. When the Fed began tightening monetary policy in March 2022, the yen depreciated significantly. In July of this year, the yen depreciation reached an all-time high, at which point the interest rate differential was at its widest.

After the Bank of Japan raised its policy interest rate from 0.10% to 0.25% at the end of July, the yen rebounded strongly. The Bank of Japan has made it clear that it will start raising interest rates at some point in the future. The market finds it difficult to predict when they will begin to raise rates. Like an unstable snowpack, it is hard to foresee which snowflake or turn in skiing will trigger an avalanche. A 0.15% reduction in the interest rate differential should be insignificant, but that is not the case. The trend of a strong rebound in the yen has begun, and the market is now highly focused on the future trajectory of the dollar-yen interest rate differential. As expected, after Powell shifted policy, the yen received strong support as the interest rate differential is expected to further narrow.