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March CPI Comes In At 8.5%

On Monday night, Jenn Psaki, the White House Press Secretary warned that the Consumer Price Index for the past month would be "extraordinarily elevated". At 8:30am today, the official number was released at 8.5%, the highest in 40 years, driven by a 32% increase in the cost of energy and 8.8% increase in the cost of food. In the White House statement, this "extraordinarily elevated" CPI was referred to as the "Putin price hike", attributing much of the inflation to the Russian invasion of Ukraine, despite CPI >6% since October.

While the devastating Russian invasion of Ukraine has absolutely exacerbated inflation numbers, it's clear inflation was trending upwards well before this event. Between gross increases in the monetary supply from COVID stimulus packages and supply chain disruptions due to federal and overseas COVID policies, roaring inflation has been coming for months.

The Federal Reserve Bank is mandated to maintain price stability. In doing so, they attempt to target a consistent ~2% inflation rate. To combat rising inflation numbers, the Fed rose the overnight lending rate 25 basis points (0.25%) last month, with plans to continue to increase rates at least 6 more times this year while also ending their Quantitative Easing (QE) purchases of U.S treasuries and mortgage-backed securities. These purchases have averaged $80 Billion a month since 3/2020 (you can see the list of purchases here), and there are additional plans to roll off their $9 Trillion balance sheet (Quantitative Tightening). The Fed signaling these policy shifts has contributed to near parabolic move upwards in 10-year treasury yields, which means bonds are selling off rapidly. (for a refresher on bond yields read our recent post on yield curve inversion)

The 10-Year U.S Treasury is the main vehicle by which the U.S government service its debts, which currently sits just below $30 trillion, up ~$7 trillion since the start of the COVID-19 pandemic (2020), and nearly $20 trillion since 2008.

Treasuries are government bonds that are typically purchased by other countries, private companies, banks, individuals, retirement accounts etc, and during recent times, Central Banks. For lending the U.S government their money they are paid an interest rate (in fixed coupons). For the past 2 years this has been <1% , due largely to the Fed’s COVID response (QE , Fed Funds rate at 0).

With the Fed stopping QE, this withdraws a large, constant purchaser from this market. As a result, you would expect supply of bonds on the open market to be higher than during this last round of QE. This increase in supply causes yields to rise. Further, with inflation coming in at 8.5%, you may be wondering who would own a bond only giving you a 1-2% yield if held to maturity? Even with bonds selling off, the current 10-year treasury sits at 2.79%. That means the real yield for someone holding a 10-year treasury is -5.71%. Put in other words, if inflation continues at this rate, you are guaranteed to lose 5.71% of your money

As we noted earlier, Treasuries are the main vehicle of how the U.S Goverment services it’s debt. If this trend continues, and the 10-year yield continues higher, the U.S Government will have higher and higher interest payments on the money it borrows to meet its liabilities...on the order of >$1 Trillion per additional 1% rate increase to the 10-year.

It is due to this debt servicing issue, that we believe inevitably the U.S government and the Fed will likely let inflation run high over the long term. While they attempt to squash demand in the intermediate term by introducing rate hikes and QT, this cannot continue without serious ramifications. They inevitably will have to reinstate QE and bring down the fed funds rate to bring down Treasury rates if they become too elevated due to sell off.

The big issue for the Fed and U.S Government comes if the bond market continues to throws a fit despite reinstating QE. With inflation continuing to run hot , and if bond demand dwindles as a result, you may see them have to instate yield curve control as a last ditch effort. Yield curve control is where the Fed will purchase any government bond at a fixed targeted rate. For example, if the Fed set a targeted rate at 0.5%, they would purchase any treasury that sells at or above that rate. This would mean massive monetary expansion most likely dwarfing the $7 trillion in monetary expansion in the past 3 years.

What does this mean for Bitcoin? In the medium to long term, most likely a parabolic move upwards as money moves out of the $46 trillion dollar US bond market that no longer provides a positive real yield, coupled with growing inflation (the dollar becoming less valuable in relation to Bitcoin) and an ever bloating US equities market. Despite this, there are possible tough roads ahead in the short term for Bitcoin as many still treat the asset as a risk asset, and during times of uncertainty (recession/war) capital tends to flow out of risk assets and into more "stable" assets such as gold, silver and the dollar. Its hard to say with any certainty what may happen next, but volatile times are most likely ahead.


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