After Bitcoin fell below $35,000, it is time to buy the dip

US Treasury Secretary Janet Yellen and the goofy Fed Chairman Jerome Powell are vacillating between decisive action and evasive rhetoric. When they act, you'd better not fight them, but when they just shout slogans, be careful, because many market signals can mislead you into a path that is bound to lose money.

On November 1, 2023, the U.S. Treasury’s Quarterly Refinancing Announcement (QRA) included a statement that Janet Yellen would shift the bulk of borrowing to short-term Treasury bills (T-bills) with maturities of less than one year. This prompted money market funds (MMFs) to withdraw funds from the Fed’s reverse repo program (RRP) and invest in higher-yielding Treasury securities. The results, described in detail in my article “Bad Gurl”, were and are providing a liquidity injection that will total nearly $1 trillion once completed.

In mid-December 2023, at the FOMC press conference, Powell announced that they were discussing a rate cut in 2024. This was a dramatic turn from his comments two weeks ago, when he assured the market that the Fed would remain tight to ensure that inflation would not return. The market interpreted this as meaning that the first rate cut in this round of rate hikes by the Fed would occur in March of this year. Then, earlier this month, Dallas Fed President Logan threw out a smokescreen that the pace of quantitative tightening (QT) would gradually slow down when the RRP balance approaches zero. The reason is that the Fed does not want any problems with US dollar liquidity when it stops printing money.

Let’s review what was all talk and what was actually done. Yellen switched departmental borrowing to Treasury bonds, thereby adding hundreds of billions of dollars of liquidity so far. This is actual money flowing into global financial markets. Powell and other Fed governors talked a big game about cutting interest rates and tapering the pace of quantitative easing in the distant future. This talk did not add any monetary stimulus. Yet the market treated the actions and the words as the same thing and rallied after November 1 and continued to rise throughout the month.

The markets I'm referring to are the S&P 500 and the Nasdaq 100, which are both hitting all-time highs. But all is not well.

The real alarm for the direction of USD liquidity – Bitcoin – is sending warning signals. Bitcoin has fallen from a high of $48,000 to below $40,000 after the launch of the US spot ETF. In line with Bitcoin’s local high, the 2-year US Treasury yield hit a local low of 4.14% in mid-January and is currently rising.

The first argument for Bitcoin’s recent plunge is outflows from the Grayscale Bitcoin Trust (GBTC), which doesn’t hold water because when you net GBTC outflows with inflows into newly listed spot Bitcoin ETFs, the result is a net inflow of $820 billion as of January 22nd.

The second argument, and my position, is that the Bitcoin market expects the Bank Term Funding Program (BTFP) to be suspended.

This event will not have a positive impact because the Fed has not yet lowered interest rates to levels that would push 10-year Treasury rates to the 2% to 3% range. At these levels, the bond portfolios of non-too-big-to-fail (TBTF) banks have returned to profitability, while there are currently large unrealized losses on their balance sheets. Until interest rates fall to the levels mentioned above, these banks cannot survive without government support through the BTFP. The exuberance in financial markets has given Yellen and Powell a false confidence that the market will not let some non-TBTF banks fail once the BTFP is suspended. Therefore, they believe that the politically toxic BTFP can be stopped and there will be no negative market reaction. However, I believe the opposite is true: the cessation of the BTFP will trigger a mini-financial crisis and force the Fed to stop talking and allow Yellen to start cutting rates, tapering QT, and/or resuming money printing through quantitative easing (QE). Bitcoin's price action tells me that I am right and they are wrong.

The Fed would rather stimulate the market through speeches and Wall Street Journal columns because they are extremely afraid of inflation. The warmongering puppets in charge of the peaceful foreign policy under the United States are now embroiled in another Middle East war and a never-ending struggle with the Houthis in Yemen. Later in this article, I will elaborate on why this war is important and may lead to a disturbing spike in commodity inflation on the eve of the US election in November this year.

Contrary to what the mainstream financial media in the West tells you, inflation is still a problem for most broke Americans. Voters decide their president based on the economy, and right now, US President Joe Biden and his Democrats are destined to be defeated by redneck representative Trump and the Republicans.

As I wrote in “ Signposts ” , I believe Bitcoin will fall before the BTFP update schedule is decided on March 12. I didn’t expect it to happen so soon, but I think Bitcoin will find a local bottom between $30,000 and $35,000.

As the SPX and NDX fall due to the mini financial crisis in March, Bitcoin will rise because it will represent the Fed finally turning its rate cut and money printing rhetoric into action of pressing the “Brrrr” button.

Now, I will quickly walk you through some charts and graphs to give you an idea of ​​why I think the Fed needs a mini financial crisis to stop the “talk”.

chart

Here is a chart of USD liquidity. The index plummeted as the Fed began its rate hikes and quantitative easing actions in March 2022. However, as MSRPs have fallen since June 2023, the index is back to its lowest level since April 2022.

This chart is a subcomponent of the index and is the net of changes in RRP and TGA balances. Since the U.S. government budget was passed in June 2023, nearly $800 billion in new liquidity has been added.

From a macro perspective, despite the reduction of the Federal Reserve's balance sheet by $1.2 trillion, risk assets are still pouring in due to relatively high levels of US dollar liquidity.

The first crisis

If we drill down into the non-TBTF bankruptcies, we see that Yellen and Powell were forced to act to save the US banking industry. The above chart is the S&P Regional Bank ETF (KRE) in white versus the 2-year Treasury yield in yellow. The banks in this index are small and medium-sized banks that do not enjoy the government deposit guarantee like the more well-known and profitable TBTF families. Yields rose sharply in the first quarter of 2023, causing KRE to plummet and three major non-TBTF banks (Silvergate, Signature, and Silicon Valley Bank) to fail within two weeks. Yields plummeted as the market knew the Fed would have to print money through BTFP to save the system.

Second crisis

All was well and good for a time, but markets began to focus on the runaway US deficit and the massive amount of bonds that had to be issued to finance it. This was compounded by Powell’s statement at the September 2023 FOMC press conference, when he said that financial markets would do the monetary tightening job for the Fed. The bond market wanted the Fed to fight inflation and raise government borrowing costs with further rate hikes, not just sit back and watch the data on the Bloomberg terminal . Rates rose across the curve, and most worryingly, long-term rates rose in a bear market steep manner, which would be fatal to the financial system. KRE responded by falling to levels not seen since the worst of the banking crisis in April. Yellen was forced to act in November to switch borrowing to Treasuries. This saved the bond market and triggered a vicious short-covering rally in stocks and bonds.

Hopium

The market is now anticipating when the RRP balance will approach zero and wondering what will happen next. There has been a lot of discussion about this, including speculation on how the Fed can increase liquidity without printing money. But no action has been taken yet. The 2-year yield has risen, but the KRE price continues to rise, and the market is drinking poison to quench thirst . If Yellen and Powell are right, the 10-year yield will magically drop from 3% to 2%. This will not happen without new dollars buying bonds. Such is the disconnect between the 2-year yield and the KRE. I believe the market is in for an unpleasant surprise as it is clear that Powell will only "rant" and not make any drastic changes.

This busy chart shows the divergence between Bitcoin (white) and the 2-year Treasury yield (green), which tell the same story, while the SPX (yellow) tells a different story. Starting on November 1, 2023, as the 2-year Treasury yield fell, Bitcoin and the SPX index rose. Once the 2-year yield bottomed and reversed direction, Bitcoin fell, while the SPX continued to rise.

Bitcoin tells the world that the Fed is caught between inflation and a banking crisis . The Fed’s solution is to try to convince the market that banks are sound without providing the necessary funds to make that fantasy a reality.

Fragile bottom layer

Jim Bianco has produced some excellent charts, which are the focus of the rest of this article.

As readers know, I spend the northern hemisphere winter in Hokkaido, Japan. One notable change during this season is the sheer number of Americans. Getting to this powder snow paradise can be a pain even for those living in Asia, and a vacation to Japan is more time-consuming and expensive if you live in the United States.

Yet, there are noticeably more baby boomers skiing at resorts in the U.S. Baby boomers are the wealthiest people of their lifetime. That’s because the stock market and home prices are at all-time highs. Plus, their cash reserves are generating income for the first time in decades, and for a group of humans who had a near brush with death during the pandemic (the flu killed mostly obese old people, the baby boomers), now is the time to travel the world.

The richest 10% of U.S. households own about 65% of the financial assets that the Fed has pumped in through its various money-printing programs. Baby boomers are the wealthiest generation, and their spending is powering a very strong U.S. economy.

The Atlanta Fed expects GDP growth to be strong +2.4% in the fourth quarter of 2023 - very strong, very strong!

However, the rest of the country is bankrupt and deeply in debt.

The top 10% hold about 65% of financial assets but only about 8% of debt. The bottom 90% hold 92% of debt but only 35% of assets.

This highly unequal distribution of wealth and debt creates a problem for politicians in a democracy. While politicians are determined to do whatever it takes to make the rich richer, they need to get elected by gaining the support of bankrupt civilians. That’s why it’s a problem when inflation sets in.

The current CPI calculation is Fugazi. If we go back to the CPI calculation method of 1980 or 1990, the actual inflation rate was about +10%, while the inflation rate you read in the news was +3%.

That's why, according to the latest polls, Trump is slightly likely to beat Biden.

In short, American politics is like a circus where the rich buy ads to boost the popularity of their favorite clowns, who then dance and sing to win the votes of the common people. Biden must distribute goodies to rich and poor alike to win. At a cynical macro level, the strategy is to drive up the stock market owned by the rich, thereby increasing tax revenues, and then use the spoils collected from the rich to provide relief to the poor.

The top 10% pay 74% of income taxes. Their outsized contribution stems from the huge capital gains taxes the government collects during stock market rallies. As a result, the finances of the U.S. government are tied to the performance of the stock market.

Biden has two “financial generals” with different missions. Yellen must use the power of the U.S. Treasury to boost the stock market. She can do this by adjusting the U.S. Treasury’s bond issuance schedule or reducing the TGA. Powell must reduce inflation to an acceptable level, which he can do by raising interest rates and shrinking the Fed’s balance sheet.

Yellen’s job is much easier than Powell’s. Yellen can unilaterally boost the stock market by issuing more Treasury bills and bonds, or by reducing the TGA from its current $750 billion to zero. Powell can reduce the money supply and raise interest rates, but he has zero control over geopolitical issues. He also cannot influence the size of the government deficit or surplus. Assuming the government is committed to maintaining a large deficit, Yellen will appropriately provide the funds, thereby increasing demand for goods and services. In this case, Powell’s anti-inflation actions at the Fed will be weakened.

The reason why inflation in the United States after the COVID-19 pandemic is so pronounced is that the government distributed stimulus measures funded by the Fed's money printing to the people at a time when it was difficult to transport goods around the world. Due to the COVID-19 lockdown and vaccine policies, there were shutdowns and labor shortages. As a result, inflation reached the highest level since the late 1970s and early 1980s.

A similar global supply chain crisis is playing out, but this time, difficulties transporting goods are being caused by El Niño and the closure of the Bab el-Mandeb Strait to Western ships.

Trumpet and Hope

Shipping is an old but important business. Compared to rail, road or air, sea transport is the cheapest per kilometer traveled. Without the Panama Canal or the Bab el-Mandeb Strait, ships would have to sail around Cape Horn or the Cape of Good Hope. The advent of the El Nino weather pattern has led to drought in the Panama Canal, resulting in below-average water levels in the canal, meaning fewer ships can pass through. Asymmetric drone warfare by the Houthis in Yemen has effectively blocked the Bab el-Mandeb Strait from Western ships. They must now sail around the Cape of Good Hope.

The rerouting affects 20% to 30% of global shipping and adds significant time and expense. For inflation statisticians, anything that travels by ship becomes more expensive, all else being equal. Given that inflation operates with considerable lags, if this persists, its effects will only be felt after several months. While markets are pleased with lower year-over-year inflation data in the U.S. and elsewhere, this could be a pyrrhic victory.

The El Nino weather pattern is just getting started. Mild El Ninos usually last one to two years. No matter how bad this El Nino gets, it will still be here this November. Sadly, if you are a Biden supporter, there is nothing he can do about the weather, and humans are not a Kardashev Type I civilization. El Nino and climate change in general have lowered water levels in the Panama Canal, reducing the number of ships that can transit.

Reducing shipping activity through the Panama Canal is important because the United States is rerouting some cargo to Eastern Seaboard ports via Europe to avoid the Panama Canal. However, shipping costs and times will increase, as cargo from Asia to Europe loaded on Western ships will now have to go around Africa rather than through the Red Sea.

The Houthis have declared that they will attack any ship from any country that supports Israel. They believe that Israel’s war on Gaza is an act of genocide, prosecuted by war criminals like Israeli Prime Minister “Bibi” Netanyahu. In solidarity with their fellow Muslim and Arab people, they are using $2,000 drones to attack merchant ships. A cheap drone can completely disable a ship worth hundreds of millions of dollars. This is the definition of asymmetric warfare. Think about it: To disable a $2,000 drone, the United States would have to launch a $2.1 million missile. Even if the Houthis never hit a single target, every drone they send out costs the United States 1,000 times more to defend against. Mathematically, this is an unwinnable war for the United States.

The cost of using expensive naval missiles (which can cost up to $2.1 million each) to destroy simple Houthi drones (estimated at thousands of dollars each) is becoming a growing concern, according to three other defense officials. –Politico

Given the United States’ responsibility for global maritime security as the issuer of the world’s reserve currency, the world is watching how the Pax Americana responds to this blatant military strike. Judging from the Houthi statements, the Houthis would stop their attacks if the United States broke off diplomatic relations with Israel and forced Bibi to end the war. However, even if the United States considers Bibi a genocidal maniac, the United States will not abandon its ally just because the government of a “shithole” country launched a few cheap drones and closed one of the world’s most important waterways.

Even if Biden loudly calls on Bibi to end the war and stop murdering so many Gaza men, women and children, Biden will never stop the financial and military blockade of the Israelis for fear of losing face. The result is that the whole world is in fear of war breaking out .

I predict that we will see firsthand how difficult it is to punch drone swarms with the mighty fist of the red, white and blue. In order for shipping companies to have the confidence to once again cross the Red Sea, the U.S. Navy will have to perform perfectly in every engagement. Every drone must be eliminated. Because even a direct hit with a drone payload could incapacitate a merchant ship. Also, with the U.S. now at war with the Houthis in Yemen, shipping insurance premiums will soar, making sailing through the Red Sea even more uneconomical.

Rising transportation costs due to weather and geopolitical factors could cause inflation to spike in the third and fourth quarters of this year. Since Powell is undoubtedly aware of these issues, he will do everything he can to talk big about rate cuts without actually cutting them. Inflation due to increased transportation costs may rise modestly, but rate cuts and the restart of quantitative easing could exacerbate the rise in inflation. The market has not yet realized this fact, but Bitcoin has.

The only thing that beats fighting inflation is a financial crisis. That is why, in order to achieve taper, QT reduction and the market's belief that QE may resume in March, we first need to let some banks fail when the BTFP is not renewed.

Tactical Trading

After the ETF was approved, 30% correction of BTC range high of $48,000 was at $33,600. Therefore, I think Bitcoin will form support between $30,000 and $35,000. That is why I bought a $35,000 put option on March 29, 2024 and also sold the Solana and Bonk trading positions at a small loss.

Bitcoin and cryptocurrencies in general are the last freely traded markets in the world. Therefore, they will predict changes in USD liquidity before the TradFi fiat stock and bond markets are manipulated. Bitcoin tells us to look for Yellen, not for talk.

Yellen has an opportunity to inject more life into the market with the upcoming QRA release on January 31st. If she announces that she will cut the TGA from $750 billion to zero, then we know there is another source of liquidity that the market did not anticipate that can support the market. The question then becomes: once the BTFP is not renewed, will it be enough to prevent any bank failures?

I believe BTFP will not be renewed as neither Yellen nor Powell mentioned it once. Therefore, the natural assumption is that it will expire and the banks will have to repay nearly $200 billion borrowed. If the situation changes and they make it clear that they will extend the maturity, then the race is on. I will close my puts and take advantage of maximum crypto exposure by continuing to sell Treasuries and buy crypto.

If my base case scenario materializes, I will start buying dips once Bitcoin drops below $35,000 and continue to buy Solana and WIF.