Tuesday, Oct 10, 2023

why are markets happy?? plus bitcoin's changing balance

“No sensible decision can be made any longer without taking into account not only the world as it is, but the world as it will be.” – Isaac Asimov ||

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Programming note: it’s a public holiday on Thursday where I live, so this newsletter will be skipping a day.

IN THIS NEWSLETTER:

• The Fed changes its tone

• Markets are blinkered

• Crypto will benefit

• Financial conditions are tight

WHAT I’M WATCHING:

The Fed changes its tone

So, yesterday started out as I expected, with stocks down, yields up, commodities up. But then a sense of relief seems to have flooded markets and directions reversed.

What could possibly trigger relief when another war has erupted in a key geopolitical region?

The answer: the Federal Reserve.

Yesterday, I said that it was now much more likely that the US is at peak rates for this cycle. Before the weekend’s events, I had thought there would be one more, because while there are signs of the economy slowing, I think inflation has some upticks ahead, and the Fed is more inclined to do too much than too little.

But the attack on Israel changed the equation - now it’s about sentiment. Markets are tense, and the Fed would probably not want to light the match that started a global meltdown. Now would be a time to hold, and be ready to cut if things get really bad on the geopolitical stage. (I think they will get really bad, and the Fed will cut sooner than is now expected, but that’s for a different conversation.)

Indeed, the tone of Federal Reserve officials seems to have changed. Yesterday, both the Dallas Fed president Lorie Logan and Fed Vice Chair Philip Jefferson suggested that the high treasury yields were doing some of the Fed’s tightening work for it.

Even more interesting, Fed officials are now talking about term premia. Logan gave an excellent description of the concept, which refers to the yield premium on longer term bonds as compensation for the risk of tying up funds. There are several ways to calculate the term premia, and it’s not an exact science - but all methods point to the term premia going up.

A couple of weeks ago, it turned positive for the first time in two years:

(chart via Axios)

Here’s an excerpt from Logan’s speech:

“If term premiums rise, they could do some of the work of cooling the economy for us, leaving less need for additional monetary policy tightening to achieve the FOMC’s objectives.”

Jefferson also indirectly refers to term premia (although he doesn’t use the term) by pointing out how longer-term yields have risen beyond what fed funds expectations would warrant. Significantly, he now explicitly says that he will take financial markets into account when determining his monetary policy view: