There are things out of the U.S. Federal Reserve’s control. The central bank has a dual congressional mandate to maintain the U.S. dollar’s long-term value and achieve maximum employment, but it’s dealing with a mix of uncertainties as it pursues those goals.
Yesterday, Federal Reserve Chair Jerome Powell announced the monetary body will begin scaling back its historic asset purchasing program, one of the key levers it pulled to support and stimulate the economy during the worst of the coronavirus pandemic.
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Beginning in November, the Fed will purchase $10 billion fewer Treasury bonds and $5 billion fewer mortgage-backed securities (MBS) each month until the $120 billion program is depleted sometime in mid-2022.
The Fed left itself some wiggle room to pause or accelerate this “taper” depending on extenuating circumstances. It also won’t consider raising interest rates while still buying bonds – more flexibility.
It cannot be overstated how experimental this monetary outlay is, especially as it begins to wind down. Known as “quantitative easing,” or QE, the bond buying program has more than doubled the Fed’s balance sheet (now valued above $8.6 trillion). It has had broad effects on the labor market, asset prices and the dollars in your pocket.
Inflation is running hotter than at any point over the past 30 years, and consumer prices have climbed 4.4% in aggregate, double the 2% target the Fed has long targeted. Conflicting signals point to both a super-tight and super-loose labor market simultaneously. The quits rate, number of job openings, and salary and benefits paddings are all atypically high (pointing to a tight labor market). Yet, there are 5 million fewer people working than in February 2020.
“We have high inflation and we have to balance that with what’s going on in the employment market,” Powell said. “It’s a complicated situation.”
Considering the extent to which market watchers hang onto Fed-speak, Powell deserves credit for his consistent messaging. His magic voice is essentially the one thing completely under his control. Although the taper signals an end to easy money, markets weren’t spooked yesterday: the S&P 500, Dow Jones Industrial Average, Nasdaq 100 and Russell 2000 all closed trading at all-time highs.
Powell has been consistent on letting the economy “run hot,” and has made good on giving markets advance warning of policy changes. His colleagues at the Fed were unanimous in parking the benchmark interest rate between zero to 0.25% (though that, too, is subject to change, “depending”). Where Powell has changed perspective is only in a matter of degree – instead of saying elevated inflation is “transitory,” or a matter of specific coronavirus-related bottlenecks, he said mitigating factors were – shipping constraints aren’t forever.
Indeed, supply-chain logjams, superconductor shortages and strong buying demand from American consumers are all things Powell watches without having much say in the matter. Same with COVID-19 caseloads, lockdowns and market psychology.
So when it comes to tapering, or when or by how much to lift interest rates, it’s important to remember we’re watching a human being. You can disagree with his policies – and, boy, many do – but that’s an issue whenever we invest any one person with such authority.
Two sides of the coin
Bitcoin, as an alternative monetary base layer, stands apart from this human drama. A grand experiment born from the 2008 recession that was supercharged by the pandemic, most policy decisions for Bitcoin have already been made and hardcoded. It is hard where the dollar is soft. Subject to reason, where the dollar is man.
But it’s also fully integrated into the global economy and the bitcoin currency’s price is also subject to Fed decisions. Bitcoin has benefited over the past several months of QE from the belief that it is an inflation hedge. Smart money – the Ray Dalios of the world – bought into it and profited.
However, it’s unclear how the Fed will manage inflation going forward. For now, Powell has signaled that he’s choosing full employment over risks of elevated prices.
“We don’t think it is a good time to raise interest rates because we want to see the labor market heal further,” Powell said. “The level of inflation we have right now is not at all consistent with price stability.”
When the Fed starts to raise interest rates to cool the economy it could have a negative impact on bitcoin’s price. “To the extent BTC is a hedge like gold, I think it could suffer,” the economist Claudia Sahm told me in a private message.
Then again, there’s also a belief that the Fed has already let inflation run too far and has limited means to cap it. In the short term, if Powell is to remain true to his word and finish buying bonds before raising rates, the agency doesn’t have a tool to pull in inflation until at least Q2 2022. A hyperinflationary environment, or even just fears of that happening, could drive money into bitcoin.
“On the other hand, the effects of the largest QE in history may lead to the largest inflation in history, regardless of the Fed attempting to scale back. If this happens, we expect demand, and prices, for bitcoin to rise to new all-time highs,” Joe DiPasquale, CEO of the cryptocurrency hedge fund BitBull Capital, told CoinDesk yesterday.
It remains to be seen how transitory inflation is and will be.
It’s worth noting as well that Powell’s term as Fed chairman is ending in February 2022 (though his term as a Fed governor ends in 2028), and the Biden administration hasn’t given a clear signal as to whether he’ll stay on at the job. While Fed officials were in lock-step to begin phasing out asset purchases, many have contradictory views about how to manage (and even measure) inflation.
So will Powell’s mandate continue? Will bitcoin succeed in a world where the U.S. isn’t buying bonds? It’s just another human uncertainty.