Fed Cuts Rates and Yen Strengthens: Bitcoin May Enter Bull Run Again

As the summer holidays in the Northern Hemisphere came to an end, I headed to the Southern Hemisphere for a two-week skiing trip. During this time, I mainly engaged in backcountry skiing. For friends who have never experienced it, this activity requires attaching climbing skins to the bottom of the skis to ascend. Once at the top of the mountain, you remove the climbing skins, adjust your gear to downhill mode, and enjoy the fun of powder snow. Most of the mountainous areas I visited could only be accessed this way.

In a typical four to five hour skiing schedule, 80% of the time is spent going uphill and 20% is spent going downhill. This activity consumes a large amount of energy. The body burns calories to maintain temperature and internal balance. The legs, being the largest muscle group in the body, are continuously working whether going uphill or downhill. My basal metabolic rate is about 3000 kcal, and with the energy required for leg exercises, my total energy expenditure exceeds 4000 kcal per day.

Considering the immense energy required to complete this activity, a balanced diet throughout the day is crucial. For breakfast, I will consume a rich combination of carbohydrates, proteins, and vegetables, which can be referred to as "real food." Breakfast provides a feeling of fullness, but as I begin the initial uphill trek into the cold forest, those energy reserves can quickly deplete. To manage my blood sugar levels, I prepare some snacks that I don't usually eat. I will have an energy bar and syrup every 30 minutes, even if I don't feel hungry. I don't want low blood sugar levels to affect my performance.

Relying solely on processed foods high in sugar cannot meet energy needs in the long term. I also need to consume "real food". After completing a lap, I usually stop for a few minutes to open my backpack and eat my homemade meal. I prefer chicken or beef packed in a preservation box, stir-fried leafy vegetables, and a large amount of white rice.

I maintain my performance throughout the day by periodically consuming high-sugar foods, combined with cleaner, real foods that burn longer.

The dietary preparations for this skiing trip have led to discussions about the relative importance of currency price and quantity. For me, the currency price is akin to energy bars and syrup, providing a quick boost of glucose. Meanwhile, the currency quantity is like the "real food" that burns slowly and sustainably. At last Friday's Jackson Hole central banking conference, Powell announced a policy shift, as the Fed finally committed to lowering policy interest rates. Additionally, officials from the Bank of England and the European Central Bank also indicated that they would continue to lower policy interest rates.

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

The initial positive reaction in the market is reasonable, as investors believe that if currencies become cheaper, assets priced in fixed supply fiat currencies should go up. I agree with this view; however, we have overlooked that future expectations of rate cuts from the Fed, the Bank of England, and the European Central Bank will reduce the interest rate differential between these currencies and the yen. The risks of yen carry trades may re-emerge and could undermine this bull run, unless the amount of currency is increased in the form of central bank balance sheet expansion.

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

If the interest rate cuts by the three major economies lead to the appreciation of the yen against their domestic currencies, then we should expect a negative market reaction. We are facing a struggle between positive (interest rate cuts) and 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 due to the rapid appreciation of the yen will outweigh any benefits gained from the minor interest rate cuts in the USD, GBP, or EUR. Furthermore, I believe that the decision-makers at the Fed, Bank of England, and European Central Bank realize that they must be willing to ease policies and expand their balance sheets to offset the adverse effects of yen appreciation.

The Fed is trying to gain short-term stimulus from interest rate cuts before an economic recession arrives. From an economic perspective, the Fed should have raised interest rates instead of cutting them. Since 2020, the U.S. 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 risen high enough to force politicians to raise taxes or cut subsidies to balance the budget.

If the Fed truly wants to maintain confidence in the US dollar, it should raise interest rates to curb economic activity. This will generally lead to a decrease in prices, but it will also result in some people losing their jobs. At the same time, this will also control government borrowing, as the cost of issuing debt will rise.

The US economy only experienced two quarters of actual GDP contraction after the COVID-19 pandemic. This is not a sign that a weak economy needs interest rate cuts. Even the recent estimate for actual GDP in the third quarter of 2024 reached +2.0%. This again indicates that this is not an economy affected by excessively restrictive rates.

The Fed is committed to never allowing financial markets to 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 are not concerned with their actual returns. Nominally rising stocks also increase capital gains tax revenues in fiat currency. In short, a market downturn is harmful to the health of the US financial system. Therefore, Yellen began intervening in the Fed's rate hike cycle in September 2022. I believe Powell is sacrificing himself under the guidance of Yellen and Democratic leaders, choosing to cut rates when he knows he shouldn't.

As the U.S. Treasury, under Yellen's control, began issuing a large amount of Treasury bonds, pulling funds out of the Fed's reverse repurchase program and flowing into the broader financial markets, the stock market experienced a noticeable rise.

The U.S. economy is not eager for interest rate cuts, but Powell will provide stimulus. Due to the monetary authorities' extreme sensitivity to any drop in the prices of legal stocks, Powell and Yellen will soon offer "real food" in some form, namely expanding the Fed's balance sheet to offset the impact of the yen's appreciation.

Powell made policy adjustments based on a controversial employment report. The U.S. Department of Labor released a significant revision of previous employment data just days before Powell's speech in Jackson Hole, indicating that the employment estimates were overstated by about 800,000.

When politics overrides the economy, I am more confident in my predictions. This is because the politicians in power want to maintain their authority. They will go to great lengths, 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 elections in November. The economy will not lack cheap and abundant fiat currency.

The exchange rate between currencies is mainly influenced by interest rate differentials and expectations of future changes in interest rates. The USD/JPY exchange rate shows a significant correlation with the USD-JPY interest rate differential. When the Fed began tightening monetary policy in March 2022, the yen depreciated sharply. In July of this year, the yen depreciation reached a historical 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 made a strong recovery. The Bank of Japan clearly stated that it will begin to raise interest rates at some point in the future. The market finds it difficult to predict when they will start raising rates. A 0.15% reduction in the interest rate differential should have been 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 trend of the USD-JPY interest rate differential. As expected, after Powell changed his policy, the yen also gained strong support as the interest rate differential is expected to further narrow.

If traders unwind their dollar-yen arbitrage positions when the yen appreciates sharply, the short-term stimulus from Fed rate cuts may quickly dissipate. Taking further rate cuts to prevent declines in various financial markets will only accelerate the narrowing of the dollar-yen 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 currency by the constantly rising Fed balance sheet, to stem the losses.

If the yen accelerates its appreciation, the first step will not be to restore the quantitative easing policy. The first step will be for the Fed to reinvest the cash from maturing bonds into U.S. Treasuries and mortgage-backed securities. This will be seen as a halt to its quantitative tightening plan.

If the painful trend continues, the Fed may use central bank liquidity swaps and/or resume quantitative easing. In this context, Yellen will increase dollar liquidity by selling more government bonds and reducing fiscal account balances. Neither of these market manipulators will use the destructive impact of the end of yen arbitrage trading on the market as a reason to resume aggressive money printing.

If the USD-JPY exchange rate quickly falls below 140, I believe they will not hesitate to provide the "real food" needed for the fiat currency financial market.

In the final phase of the third quarter, the conditions for fiat liquidity couldn't be better. As cryptocurrency holders, we have the following tailwinds behind us:

1. Central banks around the world, especially the Fed, are lowering the cost of funds. The Fed is still cutting interest rates while inflation is above its target, and the U.S. economy continues to grow. The Bank of England and the European Central Bank may further cut interest rates at their upcoming meetings.

2. Yellen promised to issue $271 billion in treasury bonds by the end of the year and conduct a $30 billion repurchase operation. This will inject $301 billion in liquidity into the financial markets.

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

4. The Bank of Japan is extremely concerned about the speed of the yen's appreciation following its meeting on July 31, 2024, at which it raised interest 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 believe the market will decline, we will not raise rates."

As a cryptocurrency investor, I do not pay attention to the stock market. Some have pointed out historical examples of the stock market falling when the Fed lowers interest rates. Others worry that the Fed lowering interest rates is a leading indicator of recession in the US and developed markets. These views may be correct, but what is worth considering is what measures they would take if the Fed lowers interest rates while inflation is above target and economic growth is strong. They are likely to