Whilst the crypto market remains suppressed compared to its all-time highs this time last year, it has held up surprisingly well through September. The month saw continued weakness in fiat currencies and stocks, but crypto has remained steady over the period with Bitcoin maintaining support at around the $19,000 level.
The biggest crypto event during the period was the Ethereum merge, which saw Ethereum move from a proof of work to a proof of stake model. While the merge was technically successful, it turned out to be a "buy the rumour sell the news" event in price terms, with the price of Ethereum underperforming Bitcoin over the last month. One of the concerns is that Ethereum is in effect becoming less decentralised, with more and more power and control being in the hands of a small group of known developers that may decide or be coerced to make further changes to the protocol.
The best performing major crypto was XRP which saw a 44% increase over the period.
Trading volume for the month is dominated by USDT, which remains by far the stablecoin of choice. Meanwhile, Bitcoin trading was over $1T from the month, more than double that of Ethereum.
Everything other than the US Dollar is down over the last month. Gold and the S&P 500 have seen further drops over the period fueled by fears of an imminent global recession. Crypto is down substantially from its all-time highs this time last year, but has shown some stability over recent weeks in comparison to other assets.
Inflation continues to head higher in most countries.
The US has managed to bring inflation down slightly in the last couple of months, primarily through substantial drawdowns of the nation's strategic oil reserves, which have helped to temporarily suppress oil price increases. Those reserves will eventually need to be refilled, which will lead to further demand and upwards price pressure.
Whilst official US inflation remains below 10%, the US Producer Price Index is up over 40% this year. Sooner or later this cost increase is going to find its way into consumer prices and further increased inflation.
Meanwhile, in Europe, inflation continues to go up. Fuel prices remain one of the principal causes, which will be further exacerbated by the mysterious explosion to the Nordstream pipeline that definitely wasn't conducted by the United States, and was nothing to do with the US saying they would end Nordstream 2 and is in no way related to the US energy industry now benefitting from exporting more LNG to Europe.
Over in the UK a massive collapse in the value of the pound brought the UK pension industry to the brink of collapse. The Bank of England was forced to announce a massive £65Bn bond-buying programme, despite planning to commence quantitative tightening this month. This further chunk of money printing will inevitably lead to further increases in inflation down the road.
Central banks continue to raise rates in an attempt to combat inflation. The US has hiked rates aggressively to 3.1%, and the UK and Eurozone have both also implemented further rate hikes.
Central bank rates remain a long off inflation levels, with the EU fighting near double-digit inflation with an interest rate of just 1.3%.
Aggressive rate rises in the US, combined with perceived safe haven status, have seen the Dollar continue to strengthen over the period. In return, this has continued to weaken almost all other currencies.
The weakness seen in other currencies is only going to accelerate the rate of inflation in those countries as they have to buy expensive US Dollars to pay for their imported goods.
Meanwhile, the US is sheltered from inflation to some extent by the strength of the dollar, however this strength will be severely affecting their export market and could lead to further economic slowdown in the US. The number one export from the US is refined petroleum. What do you do when your strong currency is making your key exported product too expensive? You take out your competitor. But the US would never do something like that, especially if the country you are selling to is a key ally.
How much longer the Dollar continues to maintain this strength remains to be seen.
Funds are pouring into US Dollars as it is currently perceived as the least bad option. The Dollar may be performing better than other currencies, but it is still losing over 8% of its value every year to inflation. At that rate, it halves in value every 9 years.
If US inflation continues to rise, there will eventually be a point at which inflation is so high that the perceived safety benefits of the US Dollar will be outweighed by the loss of buying incurred by holding it. Imagine if US inflation was 20%, would you buy the Dollar knowing that you will lose 20% every year? What about 30%, 40%, 50?. At some point, there is a level at which the crowd decide that inflation is just too high, irrespective of what the interest rates are.
When this point arrives investors will need to move their money into something else. It's unlikely they will choose other fiat currencies as these are also in massive inflationary decline. They could choose stocks, but that seems a risky bet given the impact loose monetary policy has on massively overinflated stock prices over the last decade. They could choose real estate, but that sector is massively laden with debt and primed for a price correction once increased interest rates take hold. So that really only leaves two obvious choices: either precious metals or cryptocurrencies (or both).
Historically central banks have sought to control inflation by raising interest rates above the rate of inflation. The US, which is leading the world on rate rises, remains a long way off achieving this. Current US interest rates of 3.1% are less than half the 8.2% rate of inflation.
The difference between interest rates and inflation is known as real interest rates. This means that right now in the US real interest rates are -5.1%. If you invest in US Dollar denominated bonds you can expect to lose 5.1% purchasing power per year. It is simply astounding that the market considers this the best place to park your money at the moment.
The US Federal Reserve remains committed to further rises to bring inflation under control.
The UK has already capitulated on its threat of tighter monetary policy by announcing emergency purchases of government bonds to stabilise the pound. This leaves the Bank of England in the bizarre situation of printing money to buy bonds, which will cause inflation, whilst simultaneously raising interest rates in an attempt to reduce inflation.
So the UK has capitulated. Now the question is when will the US Federal Reserve capitulate and pivot on its current plan to increase interest rates to whatever level is necessary?
It's worth keeping in mind that the FED's strategy is to reduce inflation by reducing demand. It actively intends to do this by making you poorer or even causing you to lose your job by increasing the cost of borrowing. The FED is actively trying to crash the economy, they just foolishly think they are clever enough to cool it down without causing a crash.
Rising interest rates have a severe impact on government borrowing costs. A third of the US debt is refinanced every year, and when the US government has to refinance its whopping $30.5 trillion debt it will have to do so at market competitive rates. This will massively increase US government interest payments. It is simply mathematically impossible for interest rates to rise above real inflation rates without bankrupting the government.
The question will be, when the government needs to borrow even more money to pay the interest on this debt will the FED step up and provide that funding or will they stick to their promise of quantitative tightening? The Bank of England have already given us a clue what happens when the system starts to fall apart ... they capitulate and print. The FED will do this too. It's only a question of when.
According to the latest CME forecast, US interest rates are now expected to peak at 4%, just 0.9% away from the current rate of 3.1%. The anticipated peak rate is flattening over time, indicating that the market suspects the FED is starting to approach the ceiling of what it can do in terms of rate rises.
The days until the FED pivots are also reducing according to the CME forecast. The FED is now expected to pivot in around six months time.
The FED has managed to achieve a very modest level of quantitative tightening, reducing its balance sheet by 1.8% from $8.96T to $8.79T.
So, they have managed to reduce the balance sheet by 1.8%, after increasing it by 800% since 2008 and by 125% in the last two years alone. It is highly unlikely that the FED is going to be able to make any meaningful reduction to its balance sheet, and if anything we will see the balance sheet start to go up again as soon as the government starts to run out of money again.
Internally, the FED is mainly focused on the unemployment rate, watching for an up turn (which it is actively trying to create). US unemployment may be starting to edge up very slightly. We have to remember that this is a lagging indicator, so it takes several months for the effects of increasing costs to be felt in the jobs market. Also unemployment doesn't account for the people who are taking two jobs to make ends meet.
Everyone is trying to work out what happens now, but nobody is sure and we are in very unpredictable and chaotic times. What we do know at this moment is:
It's not a question of if the market will fall out of love with the Dollar but when. It's becoming clear that under the current administration, the US government is prepared to go to extreme lengths to shore up its collapsing currency and maintain the US global reserve status. They have shown they are prepared to go as far as sabotaging critical energy infrastructure that supplies one of their closest allies and are prepared to allow the dollar wrecking ball to continue to demolish other currencies putting those countries under extreme inflationary pressure.
Crypto has held up reasonably well over the last month despite the chaos. Of course, there is potential for further pullbacks, but it is looking increasingly likely that crypto is bottoming and starting to present itself as a safe haven asset that can't be manipulated by government cronies.
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