Next year is going to be a pivotal one: it’s the year when the fed will start to ratchet up those interest rates. This is going to have profound implications not only for the u.s economy, but on nearly every asset class out there. In this video, i’m going to tell you exactly what this means and how it’s going to affect your portfolio. I also have a few predictions that you don’t want to miss, stop from the top there’s some info that i need to drop.
As is clear from this swag attire. I am no financial advisor. Everything in this video is informational and educational, with a dash of occasional and sensational content. With that preamble out of the way, i will say good day to all the new viewers out there today. My name is guy and i’m the main guy over here.
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However, this video’s reach is measured by view time. So bear that in mind. Okay enough of my nattering pitter patter time to dive into this tapering matter, i think we need to start with a bit of an overview of the current monetary landscape. This will help us to better understand the impact of potential changes next year. So in case you were quite literally living under a rock the past two years, we’ve had a teeny, tiny problem plaguing the global economy of late.
In response to this, the fed has embarked upon one of the most expansive and unprecedented monetary policy actions in its entire history. In order to stimulate demand in the economy, the fed used all the tools in its toolbox to flood the system with money and that’s not just hyperbole. That’s an actual quote from a 60 minutes interview last year, fair to say you simply flooded the system with money. Yes, we did that’s another way to think about it. We did still one of my most favorite interviews from a fed official any who.
The first thing that the fed did was cut the target for the federal’s fund rate by 1.5 percent to a target of zero to 0.25. For those who don’t know, this is the rate at which banks borrow from each other overnight. It’s a pivotal benchmark for short-term interest rates, but also feeds into the longer term rates, but that’s nothing compared to one of the fed’s most ambitious actions that was the wide scale quantitative easing it embarked upon, formerly called open market operations.
This was when the fed went directly into the market and bought securities. These included not only treasury bills, but also mortgage-backed securities right out of the gates. The fed said that it would buy 500 billion dollars of treasuries and 200 billion dollars in mortgage-backed securities. This was done over a series of months in 2020, but it wasn’t just mortgage-backed securities that the fed was buying. It even took the incredible step of buying more risky corporate debt.
Yep. That’s right. Bonds issued by companies were being put on the fed’s balance sheet. In order to pump liquidity into the system over a three and a half month period of the pandemic last year, the fed printed over 3.5 trillion dollars.
To give you an idea of just how much money was eventually printed. Take a look at this graph. It shows the total m1 money supply in the system and here’s a fun fact in just three months. Last year, the fed printed 20 of all the money it had ever printed in its entire 109 year history, some mind-blowing any who – that was all done with the intent of supporting the economy and labor market of making credit easy to access and hence bolster consumer spending and Investments by corporations now, while this may have helped to stave off the worst of the economic crash, it did have some unintended consequences. One of those was, of course, the rapid allocation of capital into nearly all risky asset classes.
These include the likes of stocks, real estate and crypto investors were deploying this ocean of liquidity and inflating the prices of all these assets. The markets became drug addicts and fed money was their drug of choice. Then, of course, you had the impact that this stimulus had on inflation, a topic that I’ve covered ad nauseam on this channel. More money was in circulation at a time when there were fewer goods due to supply chain issues, so you had more money chasing limited goods. The perfect formula for inflation fast forward to December of this year, the labor market is looking a lot more healthy, but only time will tell whether the ends justified the means we have record high asset prices and record high inflation.
It’s against this backdrop that the fed finally accepted inflation is a serious concern and began its tapering exercise. So just a bit of terminology here tapering refers to a reduction in the rate of government monthly purchases. You can basically think of it as akin to slowing down the money printer, so monetary stimulus is still being fed into the economy. The tapering was first announced in November of this year. Jay Powell said that they would be reducing the monthly bond buying program by 15 billion dollars a month, 10 billion dollars less in treasuries and 5 billion less in mbss.
However, given those crazy inflation numbers that we saw in December, the fed decided to once again speed up this taper. It would double the unwinding rate to 30 billion dollars a month, 20 billion and 10 billion for treasuries and mbs’s respectively. You can see what the respective taper timeline looks like on this graph over here now. Under these projections, the bond buying program should come to an end by march of next year. That will be it no more money pumping into the system.
Now, despite this mention of the accelerated taper, the fed did leave its benchmark interest rate unchanged. Some thought that it should have done more on that front, given the increasingly worsening inflation. Perhaps that’s the reason that the markets didn’t freak out due to the fed meeting in december no immediate end to the low rate environment that they were getting used to now. Of course, that will be coming to an end next year, projections that were released after the fed meeting showed that the majority of the governors expected at least three rate hikes next year. That’S presented here in this graph of what the fed calls dot projections now i’ll leave a link to these fed projections in the description for you.
So it’s going to be a significant shift in monetary policy by the fed, and, yes, there is always a risk that it could reverse course, especially if that virus that shall not be named decides to sprout yet another new variant. However, i think that the fed has become increasingly worried about inflation. This is especially the case, given that so many people are now blaming jay powell and friends for helping to spur it on. So what does this more? Hawkish monetary policy mean for the economy.
Well, let’s start from the top: when there are higher interest rates in the economy, it becomes more expensive for people and firms to borrow. This therefore means that it impacts on the demand for credit and hence reduces consumer spending and firm investments. So, quite simply, there is less loaned money sloshing about looking for things to buy or places to invest in this should impact the stock market in a number of ways. Firstly, you have the obvious point that if there’s less money to invest in assets, then there’s less demand for stocks, there’s less general activity in the stock market as leverage is wound down, then there’s also the trade-off that people have when they think about their investments. As rates start increasing throughout the economy, that means that savings instruments become more attractive.
Investors will look to allocate their free capital back into savings products, less risky returns that come with guaranteed interest, as opposed to dividends, which can be discretionary. Then, of course, you have some secondary effects on the valuations of companies, the fewer investments that companies are making on the stock market, the less likely their growth, the less valuable their current stock prices are based on traditional, comparable metrics. You also have to consider the general growth potential of the broader economy into these valuations, the more hawkish the fed, the less consumption, the less consumption, the less corporate revenue and earnings. This then also directly impacts on a company’s bottom line. So in theory, as the fed starts to raise rates next year, it should lead to a fall in stock market valuations.
It should lead to a dampening in the demand for real estate and other assets that are often bought with credit. Now, of course, it’s not universal. There are some sectors in the stock market that do well in a rates up environment. One of the best examples of these are indeed financial stocks. I E banks and other providers why?
Well, it should be pretty obvious: they make money on interest payments and the higher rates go the better their bottom line. So, basically, banks benefit most when they’re best able to rinse us nice there’s also the question of what impact these rate hikes have on alternative assets like precious metals and, of course, cryptocurrency. Well, that all depends on whether the fed’s changing stance has the desired result. More specifically, will this response by the fed be enough to slow down that inflation? Now there are many people who think that these moves by the fed are not going far or fast enough.
Firstly, there’s the fact that although the taper has begun, the bond purchases will continue until march. There is still more money being pumped into the economy, which means those inflationary effects are likely to continue. Moreover, even if the fed is likely to mop up some of that money supply, we cannot forget that there are exogenous factors that are impacting prices as well. These are those supply chain issues that i talked about earlier. These cannot easily be fixed, they’re global and are currently being driven by factors way beyond the control of the fed.
According to many industry executives, they’re now, planning for supply, chain issues and shortages well into the new year, some even predict the issues to last until 2023. Moreover, these assumptions were made before the rapid emergence of this omicron variant, which now appears to be another headache for global supply chains. The world is also looking increasingly unstable, geopolitically next year and if conflicts erupt, then this could push energy and oil prices to all-time highs. More inflation again, so, despite how much the fed may try monetary policy is unlikely to be incredibly effective against these external factors. Moving on from this, there is a very powerful secondary effect of inflation that you have to consider.
This is the impact of inflation expectations. On actual inflation, more specifically, if people have an expectation of higher inflation, then they are likely to raise prices preemptively. These expectations are often tethered to how seriously people think authorities are taking that threat of inflation. These inflation expectations have been shooting up recently, which shows that these consumers at least, are more concerned about the fed’s ability to bring down those inflationary pressures. Now i encourage you to read this opinion piece by economist Mohammed al-aryan.
He makes a strong case as to why the fed needs to do more now in order to tame that inflation. It’s quite compelling that’s linked to in the description by the way. Okay, so that’s the lay of the land in fiat country, but how is fed action next year likely to impact on assets like cryptocurrency? Well, let’s start with bitcoin. Shall we if there is one thing that has been made clear over the past two years, it’s that bitcoin has behaved a lot more like a risk on asset, in other words, portfolio managers and investors view it more as an asset class to generate strong returns and Not one to act as a safe haven, you only need take a look at the much higher levels of correlation with equity markets that we’ve experienced over the past two years.
For a recent example, you have the stock market crash earlier this week. This came on the back of not only more omicron virus fears, but also because of the collapse of the build back better bill. Long story short: all this spending would have meant more money flooded into the economy and hence increased economic growth. Of course, the crypto markets took a bath as well, taking a look back over the past two years. Perhaps one of the biggest stock crashes happened in march of 2020 on those virus shutdown fears in that crash bitcoin fell almost harder than stocks.
Yes, part of this may have been driven by high leverage, but you cannot deny that the global macro Fudd had an impact. Then, of course you had that epic rally that we saw with bitcoin out of the pandemic, one of the best performing asset classes on record. It also makes logical sense: it’s not as if those same institutions and individuals that were awash with liquidity were investing exclusively in stocks. They were looking at all those assets that could give them strong returns risk on. So the question then becomes if the fed withdraws that liquidity and the stock markets start to fall, could bitcoin follow suit.
Well, I’d be lying. If i said that it wasn’t a strong possibility, as we’ve seen over this year when there were fears about potential tapering, the price of bitcoin fell. Hence, if the fed was to carry on with its plans to increase rates and rein in that monetary stimulus, then bitcoin is likely to fall with all other risky assets. That is, of course, assuming that there aren’t other reasons as to why investors would hold bitcoin, but there are, and it’s something that the fed is actively trying to rein in on the other side of the bitcoin, see what i did there bitcoin is being viewed as An inflation hedge – yes, not one in the traditional sense, but one that has indeed helped protect against the destruction caused by inflation from a purely fundamental perspective, bitcoin has all the qualities that people might look for in a store of value. There’s a protocol defined limit that cannot feasibly be altered: 21 million bitcoin.
Similarly, the rate at which new bitcoin hits the market is consistent. Every block you have 6.25 bitcoin being rewarded to the miner. This is due to fall to 3.125 bitcoin, i.
half in about two and a half years, so you have an asset that has a limited supply and an inflation rate that is constantly falling. This is, unlike other inflation, hedges or stores of value like gold, for example. Although gold is a rare metal that is technically limited by supply, it is not a protocol defined certainty. The rate of gold emission can vary on top of that. It’S not always practical for an individual to invest in gold and take self-custody of that gold.
The same way that they can with bitcoin, then, apart from these fundamental qualities of bitcoin, you also have its immediately observable track record. The most recent example is, of course, the recent cpi inflation prince that we saw a few weeks ago at 6.8. This was the fastest pace that we’ve seen in nearly 40 years. Well immediately after the release of the inflation data bitcoin rallied by almost four percent, how did gold do?
Well? It also reacted to the cpi print, but it was up only 0 7, not really a massive vote of confidence when you’ve had one of the highest inflation prints on record. Let’s take a look at it over a longer time period. Let’S say the past two years during the pandemic. Prompted shutdowns here is a chart from the folks over at arcane research.
It shows the performance of bitcoin versus gold and the s p. 500. Note that gold, which is supposed to act as a hedge against inflation, is up only eight percent. Now, according to the bls, the us officially has a cpi rate, that’s over 6.8 percent.
Of course that’s if you even believe that those numbers are correct. More about that in my video, linked to in the top right, so gold has barely kept pace with inflation. On the other hand, the s p 500 has returned 33, whereas bitcoin is up over 520 and i’ll leave you to compare the performance of bitcoin with that of gold over the past 10 years. Now I’m not trying to bash gold. I would still rather hold it than treasuries or tips.
I trust it a lot more than securities issued by the government or, worse fiat issued by a central bank. Now i know what you’re thinking bitcoin is extremely volatile. How can this be a safe haven asset? Well, that all really depends on what time frame you’re looking to hold that bitcoin for, if you’re interested in the long-term preservation of wealth, then bitcoin is still unrivalled. Yes, there is still volatility in between, but that’s a factor of the nascency of the bitcoin market.
Moreover, this volatility is nowhere near as high as it used to be, and this is thanks to that wide scale. Institutional adoption that we’ve seen institutional adoption that’s likely to continue at a breakneck pace next year, especially when we see a bitcoin spot ETF. This is something that i think is actually quite likely, and you can learn more about it by watching that video up there in the top right now, i want to finish off this video with a few of my own personal thoughts. There’s no doubt that we’re continuing to live through some pretty unprecedented times. The fed has completely turned monetary policy on its head and thrown the kitchen sink at the pandemic.
The excess liquidity in the system was great for the markets, but terrible for your average fiat saver. Now that the unintended consequences of that inflation have become too great to bear, the fed is scrambling to mop up that liquidity. Of course, this means that the market’s drug of choice is being ripped from its hands and, like all drug addicts, it’s going to go through a phase of withdrawal. If the fed does go through with the taper and interest rate hikes, the stock markets are going to take a dive. This could further be compounded by softer employment numbers caused by a resurgence of the 10th 11th or 50th variant of concern, and, despite how much we would like to think otherwise, the crypto markets are likely to get caught up in this taper tantrum, as more investors start To rebalance their portfolios to less risky asset classes, so too are they likely to move out of bitcoin and crypto?
Could this lead to a bear market in stocks and bitcoin? Well, I’m more inclined to think the former rather than the latter. Inflation is a force that cannot be underestimated. Its pervasive presence over the past few months is unlikely to abate that easily, if it can at all. So as we roll into a new year with persistent and stubborn inflation, investors are going to be looking for a lifeboat.
That’s why i think the bitcoin is still the best bet against it. If one can handle the short-term volatility, that’s likely to come from the rate hikes, then it’s perhaps the best bet to protect long-term purchasing power. Now this is my opinion as a crypto guy. Of course, and most importantly, and that’s it for my video today, chaps and chappettes now i need to hear from you. What do you think will happen when the fed starts raising rates?
Will the inflation narrative dampen the initial impact? I’D love to know in the comments below and while you’re tapping away at that comment, you absolutely have to check out my socials page. This has the links to all the official places that you can follow me off. The tube. These all have blue ticks and they include my telegram channel where i share market analysis and views twitter, where i share news and other tips, Instagram and tick tock for behind the scenes, views and memes and, of course, my email newsletter.
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