Good morning. No one wrote to tell us that Monday’s wildly speculative short bet was pure madness, a testament to the very negative market sentiment among Unhedged readers, or that no one got to the bottom of the letter. We don’t know which one we like better. If you have a bet or two, please email us: [email protected] and [email protected].

Zero is not an important number right now

When negative-yielding sovereign debt first became an important part of global bond markets about a decade ago, there was a lot of excitement about it. Granted, paying someone to borrow money is a weird thing to do. Of course, negative-yielding buyers aren’t trying to make borrowers richer. They buy it either because they have to have a risk-free asset, regardless of the yield, or because they think interest rates will drop even more, giving them a capital gain. Negative-yielding debt isn’t crazy, and moving into negative territory, while psychologically important, is just another move on the financial continuum.

Now the same thing is happening in reverse. Financial pundits are excited about this chart from Strategas’ Chris Verrone, which shows that the amount of negative-yielding debt globally is falling rapidly. Note the logarithmic scale:

But Zero Barrier doesn’t tell us much. It’s not a magic threshold beyond which investors are forced into riskier assets by the presence of a negative sign and then back into risk-free debt.

What matters is the obvious fact that interest rates are rising, and why. My wonderful colleagues Kate Duguid and Eric Platt View About this Sunday. It’s not higher expected inflation that has pushed rates higher over the past month or so, but higher real rates. Here’s their inflation breakeven chart – nominal U.S. bond yields minus inflation-protected bond yields to arrive at the market’s estimate of future inflation:

Inflation is now expected to be lower than it was a month ago – not surprising given the Fed’s stance (or consensus interpretation of it) is now more hawkish. What goes up is the post-inflation rate:

Real interest rates are not only rising, they are rising rapidly. A common explanation for this is reported by Duguid and Platt, linking higher real yields to higher growth expectations. Combined with the lower balance of payments, they expect the Fed to kill inflation without killing the economy:

Analysts said the so-called rise in real yields suggested traders expect the U.S. economy to continue to expand in coming years, even as policymakers withdrew stimulus to slow strong price growth.

However, this is not the only explanation available. The other was provided to me by Edward Al-Hussainy from Columbia Threadneedle, a friend of Unhedged. He cited several examples refuting the notion that real interest rates are an indicator of growth expectations.

In May 2013, when Ben Bernanke announced that the Fed would begin tapering asset purchases sometime in the future, real interest rates rose almost immediately by 130 basis points. Presumably, this is not due to a sudden increase in growth expectations. Again, growth was strong throughout 2021, but real rates didn’t pick up until December. Looking at the longer period, we know that real interest rates in developing economies (US, Europe, Asia) have been falling rapidly over the years, although growth has not declined in all of these regions.

Al-Hussainy argues that what real interest rates tell you is how close monetary policy is to the neutral rate that economists call R*. It is the interest rate in an economy consistent with full employment and stable inflation. This is the number that matters, not zero. Unfortunately, we don’t know exactly what R* is, and there isn’t much consensus on what determines it.

What we’re pretty sure about is that R* has been dropping, and at a decent rate. Consider only one very imperfect proxy: the FOMC’s estimate of the appropriate long-term policy rate, as shown in the famous “dot plot.” in 2012, more than 4%. It is now below 2.5%.

What is the mechanism by which a tightening policy stance drives real interest rates higher? The Fed said “we will raise rates and stop buying bonds”. All else being equal, such an announcement would push up nominal interest rates and lower inflation expectations. Just by doing arithmetic, a higher real interest rate is produced.

So, given that we cannot directly observe R*, how do we know that monetary policy has reached or even exceeded R*? When risk-seeking by keeping interest rates below neutral comes to an abrupt end. “We know we’ve reached R*,” Al-Hussainy said, “when risky assets spit out on their own. That’s the only way. Otherwise, we’re just groping in the dark.”

If you believe Al-Hussainy’s explanation, you might look at what is now disgustingly risky assets and conclude that the R* has fallen even less than the Fed currently thinks it is.

Meme stocks are deflationary, but cryptocurrencies are doing their thing

Are cryptocurrencies and meme stocks related? For example, you might think of both as speculative frenzy downstream of loose monetary and fiscal policy. The government spends money, the central bank prints money, and the market goes into a frenzy.

Well, now that monetary policy is tightening, the fiscal impulse is negative Savings rates are back to normal. So you might expect all speculative junk to collapse. If that’s your point, it’s been demonstrated over the past few months:

The fallout hit meme-stock land hard, and true believers hope GameStop’s stock price will soar again. They pray for the “mother of all short squeezes” or MOASS – god from the machine By forced hedging.The most recent Wall Street Journal story Interviewed with some hangers:

Followers of MOASS say GameStop’s stock price will soar to unprecedented highs — thousands or even millions of dollars per share. The theory is that large numbers of small investors will hit the jackpot, while losses will cripple the financial elite.

[Tesla salesman Ben] Wehrman said he owns 80% of his portfolio at GameStop, and he plans to quit his job after the stress — traveling the world and working on his blog.

We will leave the final verdict to historians. But in our opinion, the pandemic has created a meme asset moment that is passing. Executives at AMC and GameStop knew this and used their inflated valuations to issue stock and refinance debt. We’ve never experienced a dramatic free fall, but now the air is seeping out. The die-hards may be right: A brief squeeze at the end of the world is the only way to restore the glory days.

Something similar is happening in the cryptocurrency space.retail investors are looking for other things to do. Robinhood’s crypto trading revenue has fallen 79% from its mid-2021 quarterly high, including a 5% drop in the most recent quarter. This is in line with the cryptocurrency’s broad decline in trading volume, which has been falling since January last year and dropped further in December:

But unlike meme stocks, in cryptocurrency retail is only half the story. Crypto companies are investing heavily in institutional money, mostly provided by venture capital. On Monday, Polygon raised $450 million from investors including Sequoia Capital and SoftBank’s Vision Fund 2.or consider scoop Last week in the Financial Times:

The startup behind Bored Ape Yacht Club, a family of non-fungible tokens with celebrities such as Gwyneth Paltrow and Snoop Dogg, is in discussions with Andreessen Horowitz for a funding round at a valuation of between $4 billion and $5 billion.

NFT pioneer Yuga Labs is seeking to sell a multimillion-dollar stake in a new funding round, according to people familiar with the matter. . .

People familiar with the talks said Yuga could even issue crypto tokens to investors and existing Bored Ape holders, which could prove valuable in the resale market.

Fading retail interest and falling prices haven’t stopped VCs, who could smell huge profits if cryptocurrencies become critical financial infrastructure. So with the peak speculation behind us, meme stocks languid, and cryptocurrencies have money to propel.

Cryptocurrencies have recovered from enough downturns to assure some commentators that a revolution is coming.This is what historian Niall Ferguson wrote in Bloomberg All weekend:

Bitcoin today is mostly seen as “digital gold”. . . as my Hoover Institution colleague Manny Rincon-Cruz pointed out in an excellent article last month, “Bitcoin’s core value proposition and technological innovation are delivered through a public, decentralized ledger. Tracking the digital scarcity of a fixed supply of 21 million bitcoins.” It’s this scarcity that investors love compared to the potentially unlimited supply of fiat currencies that the pandemic has made clear. . .

Applying financial history to the future, I expect this crypto winter to be over soon.A spring will follow, and Bitcoin will continue its steady march, not only as a volatile alternative to digital gold, but as reliable digital gold itself; and [decentralised finance] Anti-skeptics unleash a financial revolution as transformative as Web 2.0’s e-commerce revolution.

Unhedged is cautious about making predictions, but we do like thinking About the range of others’ guesses. The “Cryptocurrency Revolution” transaction is a crowded one, as is the “Cryptocurrency will go to zero” transaction. Intermediate ranges are ignored. What if encryption is only a medium-scale technological innovation that can improve the delivery of certain services? Not an exciting bet, but certainly cheap to carry. (Wu Yisen)

a good book

Half of Unhedged went to college with U.S. Olympic figure skater Karen Chen, who just won a silver medal in Beijing. On campus, Chen’s name was uttered in awe-inspiring tone. “Why is she also a premed?” was asked more than once.Jerry Brewer brings same feeling to the Washington Post page.