Pumping the brakes on QT, global dollar shortage, honey badger don't care

Europe may be forced to stop QT before it even starts, and the Fed will have to follow-suit. Bitcoin holds steady through it all.

Dear readers,

Government bonds, aside from in the UK, are now trading only one way—selling. The absence of big buyers is palpable. Not a week goes by, quite literally for three months, without higher yields. The Fed put is nowhere in sight. The BoE put, at least partially, has already been exercised. What about the ECB put? Bitcoin, to our pleasant and modest surprise, doesn’t seem to give a flying… well, let’s just say it exhibits the traits of a honey badger. And we can’t mention bitcoin’s resilience without first acknowledging that the S&P 500 remains today above its June lows despite making new 52-week lows last week. A put exists, however existential it might be, and from whichever continent it might hail.

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QT hasn’t started in Europe, already reversing course in England

Quantitative Tightening, the opposite of the famed “money printing by purchasing government bonds,” is well underway at the Federal Reserve, but the same can’t be said for England, Europe, and most recently, Japan.

QT was barely underway in England before the long end of the gilt curve started to selloff in a sloppy fashion, leading to sell pressure too immense for the Bank of England to meaningfully roll off its balance sheet; it was forced into the marginal-buying role to prevent an unwind of the UK bond market.

Europe hasn’t even started QT yet and may need to start easing already. Government bonds denominated in euro are under severe sell pressure, making the lack of central bank support punitive at the worst possible time. The Italian/German spread—the risk premium for the most fragile borrower relative to the most creditworthy borrower in the Eurozone—is widening to “crisis” levels. As the ECB looks to start unwinding its position of several Eurozone bonds, it needs to contend with sell pressure that has already widened Italian credit to the danger zone. Europe may be the next sovereign that needs to halt its liquidity contraction to stave off a systemic financial unwind.

Japan was well underway with its own QT program but recently announced a tiered bond-buying program. In the announcement, it pledged $1.7 billion to buy up the curve starting from 5s and unlimited purchases of its 10-year notes.

That’s right, even Japan, notorious for its structural bond-buying is facing such high levels of external sell pressure that an additional bond-buying facility had to be introduced.

Illiquidity in sovereign debt markets is concerning, but we believe that manic-selling will be replaced with value-buying as the global growth slowdown looms and bonds everywhere sit at historically cheap levels. The dichotomy rests in the difference between the world’s hegemonic currency, the US dollar, and everything else. Or are US Treasuries no longer immune to a withdrawal in central bank support? They have been in the past cycle (rates declined all of 2019 without any QE, and in a QT world), but arguments that secular shifts are afoot have become louder. Much more on this to come from The Bitcoin Layer next week.

In the meantime, the absence of interest rate parity between the United States and other sovereigns should inevitably incline the Fed to slow down its hikes and pause altogether. With inflation still roaring, a policy rate pause will have to come in sympathy with other central banks pausing, or cutting.

If the Fed is the only central bank in town that’s tightening, buckle up and get ready for the dollar-wrecking ball to truly take shape. Capital continues flocking to the dollar in droves, exporting even more inflation to already-struggling nations. Decisive action from the Fed is needed to ensure its actions don’t fall too out of step with its global counterparts. As much as we like to poke fun at Christine Lagarde, her recent statement that “central bankers need a coordinated policy response” is right on the money. The caveat here is that the Fed might be tired of its role as central bank of the world. That stance brings danger for Europe and emerging markets.

Shifting our focus back to home base, corporates aren’t doing much better. Higher rates and credit spreads distress those firms who can’t finance at continually higher spreads—funnily enough, that’s a lot of firms. The dollar-value of bonds trading at a 1,000+ basis point spread (10%) and loans trading below 80 cents on the dollar have more than tripled since May.

The Fed is beginning to sniff out the global dollar shortage. We’re seeing shifts at the margin that point to a pause for rate hikes. Look at the tone from policymakers:

“My best guess right now is yes, do I think inflation is going to level out over the next few months, the services, the core inflation, and then that would position us some time next year to potentially pause”

Yesterday afternoon, when Neel Kashkari said this, marked one of the first times this cycle when a Fed President used the word “pause” in any of their remarks. While the statement was riddled with the “if-inflation-goes-down” caveat, it’s very telling that a pause is being discussed openly with reporters, outside of FOMC minutes. This is yet another Fed trial balloon, where it floats an idea out to the public to see how the market responds. If the response is favorable, then the idea may be put forth into policy. We saw it in June when 75 bps was leaked to the Wall Street Journal and accepted by the market, and again last month when Fed murmurs of a 100 bp rate increase were soundly rejected by the market, and the Fed backed down to 75. Now, we’re starting to see it emerge with talks of a rate hike pause; something we’ve been discussing at The Bitcoin Layer since rates started exhibiting topping behavior back in June.

After a brief stint of hawkishness, it looks like Mr. Dovish is coming around to his old ways once again:

These are tone shifts at the margin. The majority of the Fed members are decidedly hawkish and will remain that way until suddenly they aren’t. As mentioned in Tuesday’s post, we feel that financial stress, specifically the bond selloff and dollar shortages in Europe, will be what compels the Fed to ease its foot off the hiking pedal.

Honey badger don’t care

Look at bitcoin basing and not concerning itself with the following chart, which is a straight line up in 10-year yields:

And the 10-year Treasury yield, a stunning bear run for US government debt:

We will leave you with our note from the start of the month, when 10s traded at 3.82%:

The chart is without a doubt a bearish one, especially given the lack of buying support (resistance on yield) in any shape or form. Any rally in Treasuries would have to be exogenous. The dynamic of QT is starting to hit the market in a material way, as the absence of the Fed from the buy side of the market is flooding the street with Treasuries.

Nothing has changed. There is no buyer, so the yield will rise. The curious dynamic remains the resilience of stocks and bitcoin—yields up, risk flat(ish).

Until next time,

Nik & Joe

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