By: Adam Sharp
Editor, The HIVE Newsletter
The Federal Reserve’s interest rate hikes have begun to take a major toll on the economy.
The average 30-year mortgage ticked up to 6.81% this week. That’s a 16-year high. As a result, the monthly mortgage payment necessary to buy a median-priced home in the US has risen 50%, from $1,698 to $2,559.
Home prices in previously hot markets like Austin and Phoenix have only fallen about 10% since June according to Realtor.com. But worries over a possible crash are building as higher rates crimp affordability.
Higher rates have also crushed stocks, with the Nasdaq down about 32% from highs, and the S&P 500 down almost 25%.
The Fed’s goal appears to be to whack spending, borrowing and job growth, in order to also crush inflation.
But inflation remains stubbornly high, as evidenced by the September CPI print of 8.2%. Another 75 basis point hike by the Fed in November seems locked-in, with a 100 point hike possible.
So… what if inflation still remains high? What if it’s not just caused by monetary policy, but also a product of sanctions and economic warfare?
And ultimately, how far can the Federal Reserve go with its tightening? Here’s what I wrote back in July on the matter.
I am still of the opinion that we will see an eventual Fed pivot. Meaning that our central bank will be forced to buy massive amounts of Treasuries to finance deficits and stimulate the economy.
But it seems likely there will be more pain first. A Fed pivot could be a year away, or it could happen in months. For now the Fed wants to cool off housing and other bubbles, which it possibly should have done a lot sooner.
I believe we’re getting closer to a pivot now, and that it will largely depend on if (when?) systemically-important things start breaking.
When Stuff Starts Breaking
For now, the Fed seems resolute in its mission. But what happens when something important breaks? Something, perhaps, like the housing market. A nasty housing collapse, in this environment, could help spark a new, larger debt crisis.
Housing is only one of the potential “black swan” scenarios that loom over the economy today. Higher US interest rates also appear to be contributing to a real risk of sovereign debt crises in areas such as the UK and EU.
If financial markets do start to break, will the Fed press forward, continuing to choke off liquidity? Will they stand by as another global financial crisis unfolds? As the 20% of US companies which are “zombies” (debt servicing costs > profits) go bankrupt?
(Note that the number of so-called zombie companies is now about 3x higher than it was during the global financial crisis of ‘08-09.)
The number of zombies will likely grow rapidly if interest rates keep rising, with many companies likely being forced to enter bankruptcy.
Given these factors, I continue to believe the Fed will be forced to reverse course (pivot) and initiate a new and robust QE program to stave off a major collapse. Even if inflation is still uncomfortably high.
When it does, I believe Bitcoin will be a prime beneficiary.
Bitcoin’s Unique Relationship with Fiat & the Fed
Not surprisingly, Bitcoin has also been hammered lower by the Fed’s recent tightening. It’s down about 70% from the highs it briefly reached back in November of 2021.
But let us recall what happened during the beginning of the pandemic, when Bitcoin soared from $4,000 to over $60,000 in a year as the Fed printed trillions of dollars.
On March 15, 2020, in an emergency meeting, the Fed slashed interest rates to zero and announced $700B in QE. The next day the Dow Jones Industrial Average (DJIA) plunged 12%.
The Fed’s dramatic actions weren’t enough. Markets were breaking, as chronicled by the WSJ in The Day Coronavirus Almost Broke Financial Markets.
The Fed’s bond-buying program, unveiled that Sunday, had earmarked some $200 billion for mortgage-bond purchases. But by Monday bond managers discovered the Fed purchases, while well-intentioned, weren’t nearly enough.
“On that first day, the Fed got completely run over by the market,” said Dan Ivascyn, who manages one of the world’s biggest bond funds and serves as investment chief at Pacific Investment Management Co. “That’s where REITs and other leveraged-mortgage products started getting into serious trouble.”
The Covid pandemic had just begun, but already the market was facing a serious liquidity crisis. Almost everything was crashing. Bitcoin dropped to a low of around $4,000.
Then the Fed went nuclear, adding more than $3 trillion to its balance sheet in 2020. The chart below tells the story. The gold line is the balance sheets of the G3 central banks (US, EU, Japan), which indicates QE (money printing) operations. The white/blue line is the price of Bitcoin.
It’s clear that Bitcoin tends to do quite well during periods of money printing. Here’s another way to look at it. This chart shows Bitcoin’s price growth vs. global money supply (M2) growth.
The Fed finds itself in an impossible position today. I do not envy them as their options narrow and pressure builds.
My guess is that the Fed will have to pivot at some point in the next 6 months. However, attempting to time it precisely is a fool’s errand. As investors, most of us should only aim to be directionally correct, stand firm, and buy low. That is enough. Because make no mistake, it’s going to be volatile and there will be plenty of unexpected surprises along the way.
The US, and the world will overcome this looming financial crisis. And come out the other side stronger for it. But in many ways it has just begun, and we should expect things to remain chaotic for some time to come.
One of the only things I feel confident saying about the next 5 years is that unprecedented amounts of money will be printed in an attempt to contain the damage. Personally, that means I want to have a higher allocation than normal to hard assets such as Bitcoin and gold.
Editor, The HIVE Newsletter