To investors,

Below is a guest post from Nik Bhatia, financial researcher and Adjunct Professor at the University of Southern California Marshall School of Business and author of the Substack newsletter The Bitcoin Layer, providing a preview ahead of today’s Fed meeting. Enjoy!

“Markets take the stairs up and the elevator down.” I’ve always loved this old trader adage because of how true it is, and nothing proved it like what happened this week to Treasuries, and to a lesser extent, equities and bitcoin. Today’s post is an overview of the recent chaos across asset classes and a preview of this afternoon’s Federal Reserve interest rate hike.

On Friday, official inflation data remained at a 40-year high, not necessarily a surprise to economic observers. What did surprise was the lack of any slowdown in core and headline inflation, which sent markets into a flurry of repricing. Why did some traders expect for a marginal slowdown in inflation? Interest rates have skyrocketed across the economy over the past several months, and financial conditions have broadly tightened in a significant way. But the counter effects of trillions in monetary stimulus, trillions in fiscal stimulus, supply chain disruptions, and commodity price increases have been impossible to overcome with only a few rate hikes. In fact, it can be argued that inflation is stickier than ever as our post-pandemic world is going through generational adjustments and the rejiggering of how goods move around the world, not to mention a disruptive zero-COVID policy in China.

All of this inflation, and the statistical strength of the trend, gave markets a shake Sunday evening. The Fed, which announces another rate hike this afternoon, was expected to raise rates by 50 basis points at its June and July meetings, and short-term interest rate markets reflected the same. But as markets opened in Asia and Europe on Sunday evening, a rapid adjustment ensued in Treasury yields, spilling over to risk markets. By Monday afternoon, the Fed leaked (via the Wall Street Journal) that it would be hiking rates by 75 basis points instead of 50, and the market understood that backdoor communication as a sign that July’s meeting would also see a hike of 75.

A net increase of 50 basis points in Fed hikes over the coming six weeks was enough to send risk markets into freefall. Stocks entered a formal bear market, and bitcoin fell all the way back down to $20,000, nearing its 2017 highs and lowest level since December 2020. But the real move was in Treasury yields.

The entire Treasury yield curve ratcheted higher by 50 to 75 basis points as prices went into a brief freefall (bond prices and yields move inversely), confirming the good ol’ elevator thesis. Two-year Treasury yields, which respond directly to monetary policy expectations, reached levels last seen in 2007, and 10-year Treasury yields, which trade off general growth and inflation expectations across the world economy, broke out to 2011 levels and surpassed a previously major barrier of resistance at 3.25%. The entire yield curve sits around 3.5% as of this writing. The main takeaway from all this chaos in the Treasury market and rapid adjustment in Fed hike expectations is the tightening of financial conditions.

How can the Fed slow down inflation? By slamming the breaks on the economy via tightening policy and thereby financial conditions. And the tightening trends are certainly gaining steam. First, we have mortgage rates now topping 6% which is sure to slow down the housing sector as affordability plummets due to higher borrowing costs. Elsewhere in the economy, higher Treasury yields feed directly into higher corporate borrowing costs—making credit more expensive and causing companies to slow or stop expansionary plans and hiring. To make matters worse, credit spreads, or the borrowing premium above Treasury yields that companies pay their lenders, are widening. Higher rates are already impacting economic activity, and recessionary fears have increased as the Fed seems committed to its plan of attack on inflation. And its plan of attack appears more and more like causing a recession. A mild one, or so it hopes.

Tightening financial conditions are also present in the level of the dollar versus other currencies—the dollar index is now at 20-year highs, making trillions of dollars borrowed abroad more burdensome to pay back when revenues are locally denominated. Add to that oil prices and other commodity prices at multi-year highs, and countries around the world are beginning to feel choked. Whether or not the Fed is to blame for commodity prices is besides the point—a strong dollar, expensive energy, and the reversal of hot-money trends spell disaster for emerging markets and their asset prices.

We see the decline in equities as a result from this myriad of financial tightening, and bitcoin’s correlation to the stock market has made its price collateral damage. Bitcoin has its own fundamentals, but it has been unable to escape this wave of weakness in risk markets due to global macroeconomic conditions.

Looking forward, the main question to ask is how fast the Fed’s tightening of monetary policy will bring down inflation, as every risk asset is caught in the crossfire along the way. Expect volatility to remain with us until more clarity is achieved on the path of inflation. I do believe inflation will cool down as the economy faces recessionary pressures. For now, however, it remains stubbornly high, which in turn will make the Fed stubborn on the magnitude and pace of tightening its policy rate.

Hope you enjoyed this guest post from Nik Bhatia, financial researcher and Adjunct Professor at the University of Southern California Marshall School of Business and author of the Substack newsletter The Bitcoin Layer. Highly suggest signing up here.

-Pomp

If you are not a subscriber of The Pomp Letter, join 225,000 other investors who read my personal opinion on finance, technology, and bitcoin each morning.

SPONSOR: Brave Wallet is the first secure wallet built natively in a web3 crypto browser. No extension required.

With Brave Wallet, you can buy, store, send, and swap assets. Manage your portfolio & NFTs. View real-time market data with an integrated CoinGecko dashboard. Even connect other wallets and DApps. All from the security of the best privacy browser on the market.

Protect your crypto. Whether you’re new to crypto, or a seasoned pro, it’s time to ditch those risky extensions. It’s time to switch to Brave Wallet.

Download Brave at brave.com/Pomp, and click the wallet icon to get started.

THE RUNDOWN:

Words With Friends Co-Founder Raises $46M for Web 3 Game Studio: Playful Studios, an independent game studio from Words with Friends co-founder Paul Bettner, has launched a new Web 3 subsidiary called The Wildcard Alliance and raised $46 million in Series A funding led by crypto native investment giant Paradigm. Other participants in the funding round included Griffin Gaming Partners, Polygon and venture capitalist Sabrina Hahn. Read more.

SEC Chair Gensler Suggests Lummis-Gillibrand Bill May ‘Undermine’ Market Protections: A bill intended to specify the rules and roles for crypto regulation could inadvertently "undermine" other market protections, U.S. Securities and Exchange Commission Chair Gary Gensler said Tuesday. Speaking at The Wall Street Journal's CFO Network Summit, Gensler suggested many crypto companies are already engaging in behaviors overseen by his agency, pointing to companies that offer yield for staking as one example. Read more.

EU Finance Commissioner Calls for Speedy Passage of Crypto Law: European Commissioner for Financial Services Mairead McGuinness encouraged the European Union's lawmakers to find a political compromise and speed up passage of its crypto-asset regulatory framework, currently in the last leg of the bloc's legislative process. Read more.

SEC Launches Inquiry Into Insider Trading at Crypto Exchanges: The U.S. Securities and Exchange Commission has begun an investigation into whether crypto exchanges have sufficient protections against insider trading, according to Fox Business, which cited a source with direct knowledge of the inquiry. The source said the SEC had sent a letter to a major crypto exchange asking about the kinds of protections it has in place against insider trading. The inquiry is meant to cover additional exchanges as well, according to the source. Read more.

Dylan LeClair is the Senior Market Analyst at UTXO Management, a digital asset fund investing in the analog to digital transformation of money and the emergent financial system. 

In this conversation, we why Celsius crashed this past week and how long will Bitcoin price continue to fall.

Listen on iTunes: Click here

Listen on Spotify: Click here

Pomp’s Fox Business Appearance This Week

Podcast Sponsors

These companies make the podcast possible, so go check them out and thank them for their support!

• Fundrise is largest direct-to-investor real estate investment platform. Go to Fundrise.com/Pomp today and get $10 when you place your first investment. 

• Unstoppable Domains’ 10 NFT domain endings are now fully integrated with Trust Wallet. Claim your Unstoppable Domain here today.

• Brave Wallet is the first secure crypto wallet built natively in a web3 crypto browser. Download the Brave privacy browser at brave.com/Pomp today.

• BetOnline allows you to use Bitcoin and other altcoins to bet on sports, casino games, horse racing, poker and more. Click here and use PROMO CODE: POMP100 to receive a 100% matching bonus on your first crypto deposit. 

• Abra lets you trade, borrow, and earn interest on crypto. Earn up to 13% interest on USD stablecoins or crypto, borrow USD stablecoins, and trade in 110+ cryptocurrencies in a simple, secure app. Download Abra and get $15 in free crypto when you fund your account.

• FTX US is the safe, regulated way to buy digital assets. Trade crypto with up to 85% lower fees than top competitors by signing up at FTX.US today.

• Compass Mining is the world's first online marketplace for bitcoin mining hardware and hosting. Visit compassmining.io to start mining bitcoin today!

• Choice is rebuilding the way bitcoiners approach retirement by making it possible to invest in digital assets inside your IRA. Visit choiceapp.io/pomp 

• BlockFi provides financial products for crypto investors. Those products include BlockFi Wallet, no fee Trading, crypto collateralized Loans and the World's First Crypto Rewards Credit Card. To get $75 back on the first swipe of your BlockFi Rewards Credit Card, sign up today at http://www.blockfi.com/Pompcc 

• LMAX Digital is the market-leading solution for institutional crypto trading & custodial services. Learn more at LMAXdigital.com/pomp

• Okcoin is the first licensed exchange to bring new cryptos to market. To get started, and go to okcoin.com/pomp 

• Exodus is the world’s leading desktop, mobile, and hardware crypto wallets, with over 150 assets. Founded in 2015 to empower people to control their wealth. Visit http://exodus.com/pomp today.

You are receiving The Pomp Letter because you either signed up or you attended one of the events that I spoke at. Feel free to unsubscribe if you aren’t finding this valuable. Nothing in this email is intended to serve as financial advice. Do your own research.