Market Lab Report - The Fed's 3 options; QE5?

by Dr. Chris Kacher

Markets

Last Friday's unemployment report came in strong on hiring but unemployment rose to 3.7% vs. estimates of 3.5% driven largely by the uptick in the labor-force participation rate which rose to 62.4% from 62.1%. Wage growth jumped 5.2% but was not even close to keeping up with CPI inflation of 8.5%. While some interpreted the report as weak due to rising unemployment, thus reducing the odds of a 75 bps rate hike when the Fed meets later this month, others felt the Fed has much work ahead in bringing down inflation. Markets rallied, sold off, rallied, then once again sold off in volatile fashion as expected.

The ECB hiked by 75 bps today. Powell also reaffirmed that he will keep to the dual mandate of low unemployment and price stability, quashing any hopes of a pivot. On Tuesday is both the CPI and the Ethereum merge from PoW to PoS.

The Fed's 3 options

Much debate has taken place over the level of rate hikes in the coming months. Fed chair Powell has said it will be data dependent. He has made it clear he will continue to hike until he breaks the back of inflation even if this means lower markets. If he hikes beyond an FFR of 3.5%, markets will likely nosedive as the debt service on the record levels of debt together with the growing number of defaulters takes its toll.

One alternative is if the CPI and PPI come in under expectations due to lower commodities prices, soaring inventories, and home prices coming sharply off their peak, this will give Powell a reason to hike by "only" 50 bps when the Fed meets later this month, then maybe two more 25 bps hikes to finish off the year. Markets may rally on such moves, but Powell will still be a far cry from printing money via QE 5 since an FFR near their target of 3.6% will be insufficient to lower inflation to their target rate of 2%, thus any new bull market is likely still a long way off.

Another possibility is while Powell would like to pull a "Volcker", today is far worse than the late 1970s when Volcker started hiking. Interest rates were far higher and debt was far lower, thus Volcker had room to hike into the teens. If Powell were to try such aggressive moves, the major averages would plummet well beyond 50% off their peaks. Powell is a politician surrounded by powerful people who have ample holdings in stocks, bonds, real estate, and other assets. He will not crash the markets. Instead, he will find a reason to halt rate hikes. Perhaps a new crisis emerges which allows him to justify the launch of QE5. Certainly a "we dont know what we dont know" black swan could surface given the higher order effects from the COVID lockdowns and quarantines which crippled supply chains, as well as from government regulatory overreach which prevents small businesses from getting off the ground. Small businesses are the lifeblood of an economy as this is often where cutting edge ideas are realized.

QE5?

Indeed, QE5 would be a huge buy signal. It would launch the next crypto bull market enabling leading companies to continue their path of exponential growth while new and innovative companies would join the fray. Indeed, the current $1 trillion market value of the cryptospace will inevitably grow into the tens of trillions of dollars. While some naysayers talk about crypto being over due to $2 trillion in market value evaporating into thin air, that is typical of the cryptospace. When it was just in the billions, the cryptospace had valuation corrections beyond 90% multiple times since 2010, but it is easier fodder for mainstream media to create FUD about $2 trillion up in smoke. That said, $2 trillion is a massive sum but when it comes to crypto, it can move 10 steps forward then 9 steps backward before launching to new highs once again.

Still, even with the current bear likely to get worse before it gets better due to the deeply hawkish macro environment, building has not slowed but accelerated. Web3, blockchain, and AI continue to grow at a fast clip. Top minds do not care about the price of bitcoin or the valuation of the cryptospace. They simply see solutions that carry deeply evolutionary consequences as they disrupt inferior legacy systems.