Deflation, Doubt and Squeezes
As we continue to make our way through the second half of 2020, COVID-19 continues to propagate fear, uncertainty and doubt (“FUD”) throughout the world. The United States’ unemployment (see Figure 1) along with several other labour statistics have rebounded off of their March lows as the continuous lockdown of global economies, stemming from no other than the Leviathan’s response to the virus, is forcing structural deflationary pressures on the global economy.
In response, Central Banks across the world are continuing to expand their balance sheets in an attempt to support the economy. As it currently stands, the Federal Reserve, European Central Bank, Bank of Japan and People’s bank of China have acquired a total of $25 trillion worth of assets on their combined balance sheets (see Figure 2).
Meanwhile, in the United States, Jerome Powell, Chair of the Federal Reserve, is maintaining a Fed Funds Rate target between 0–0.25%, while the Fed’s balance sheet swells to $7 trillion (see Figure 3). Vowing to “use his full range of tools” to support the economy, Powell is now willing to let economic growth spur inflation past 2%.
However, an infinite supply of Central Bank printing has (i.e. BOJ) and will continue to produce futile results. Despite the Federal Reserve’s “bazooka” buy back programs, the US inflation rate is a measly 0.6%. This number is higher than March lows, but it is nowhere near anomalous and is understandable as several parts of the US economy have begun reopening. Likewise, if a second fiscal stimulus package fails to get passed while the unemployment rate remains in double digit territory, the Federal Reserve should expect a lack of economic stimulus and deflation.
As a result of these structural deflationary pressures caused by global economic lockdowns and futile monetary policy responses, investors are fleeing to safe haven assets. Gold has just recently hit all time highs (see Figure 4) along with US government securities (see Figure 5), while Treasury Inflation Protected Securities (“TIPS”) now boasts negative yields (See Figure 6).
It is important to note that commodity markets continue to trade in lockstep with this deflationary narrative. The Goldman Sachs Commodity Index (“GSCI”) has bounced off of its March lows, but the index still continues to trade in a systematic bear market (see Figure 7). We would like to stress that if Central Banking monetary pressures were foreboding inflation, commodity markets would be trading much higher akin to the stagflation commodity market regime in the 1970’s. Clearly, there are no signs of hyperinflation as the GSCI is making all time lows, not all time highs.
In global equity markets, the situation is dire. Besides tech and the S&P 500, all major global equity indices continue to trade in a bear market (see Figure 8). The COVID-19 pandemic only propelled global equities lower after they failed to recover their 2018 highs during the early stages of the 2018–2019 US/China trade war. Similar to commodities, equity markets have bounced off of their March lows; however, unless they capture their pre-pandemic highs investors should be anticipating a rollover of this bear market rally.
Digital asset markets are seeing a similar pattern to tech. The short squeeze in FTX’s Shitperp, which tracks Small Cap Altcoins, has already turned into a bullish breakout. Meanwhile, FTX’s MidCap-Perp and Alt-Perp seem to be following accordingly. Meanwhile, several DeFi tokens have once again surpassed all time highs as investors continue to be lured into the “yield farming” mania (see Figure 9).
Despite the bearish commentary and the structural deflationary problems hindering the real economy, there are several “risk-on” markets making new local highs and all time highs suggesting, “the music is still playing”. As previously stated, tech is making all time highs as the Nasdaq Composite Index guns for 11,000 (see Figure 10). The Nasdaq’s impressive recovery from the pandemic could be attributed to tech’s software as a service model (“SaaS”), where a propensity for a lack of physical in person value exchange prevented the industry from the structural consequences caused by the lockdown.
Similarly, bitcoin has just broken out of its monthly trading range as the asset seeks to continue its parabolic trend (see Figure 11). This comes after famed macro investor Paul Tudor Jones described bitcoin as a “great speculation”. Meanwhile, as institutional investors and retail investors continue to dub the cryptocurrency “digital gold”, investors are more likely to view the digital asset as a “safe haven” asset causing investors to bid up the asset during market regimes characterized by FUD.
The current market regime is pointing to a continuation of a deflationary lead bear market with government forced lockdowns stymying economic growth and monetary stimulus anticipated to be once again futile. To capitalize on this current market regime, investors can bid up safe-haven assets, as FUD will continue to permeate global markets as we head into the 2020 Presidential Election with both candidates struggling to find the apropos mix of economic and social policy. Moreover, investors with a penchant for risk can bid up bitcoin and tech as both markets are signaling extreme bullishness to investors. Lastly, it should be noted that the current short squeeze occurring across global markets could last longer than expected as global markets continue to struggle to absorb institutional short covering.
-Edward Puccio, Digital Asset Analyst BKCoin Capital LP