We got some weird price action yesterday (Thursday). Gold gyrated wildly, at one point swinging 10% in just a couple of hours. It has retreated from the $5,500 level back to $5,200 as of this writing. Silver took a break from its stratospheric rise and fell from around $120 to $111. Bitcoin plummeted to $81k and is just below $83k as I write this. The equity indexes were hammered before recovering most of the losses on the day. These were violent moves; especially the one in gold. For much of the day, there was little explanation of what had happened other than “something broke” and “people are deleveraging”. I believe we now have an answer.
President Trump indicated he’ll make the announcement today (Friday) of who will replace Fed Chairman, Jerome Powell, in a few months. Given the President’s constant public hectoring of Powell for keeping rates too high, an assessment that I do not share, everyone expected the new Fed Chair to be an ultra-dove. (That’s finance speak for someone who favors much lower interest rates.) Instead, the prediction markets are heavily favoring Kevin Warsh. Warsh is one of the most hawkish Fed Governors. (That’s finance speak for someone who favors higher interest rates.)
Given President Trump’s requests (ok – demands) for lower rates, the likely selection of Warsh is a surprise. That’s what led to yesterday’s wild volatility. Let’s assume that Warsh is the one who will get the nod and I’ll walk you through why the market responded the way it did.
Assumed higher interest rates mean a stronger dollar. If you get paid a higher yield, you’ll be more attracted to the asset that pays that yield. Another way of saying the dollar is stronger is to say it has greater purchasing power. A dollar with more purchasing power means fewer of them are required to buy an ounce of gold and silver or a Bitcoin.
Another way to look at this is based on yield. The advantage of dollars over no-yield assets like gold, silver, and Bitcoin is you get paid to hold dollars. The advantage gold, silver, and Bitcoin have over dollars is its difficult to mine the former while the latter is being debased by the addition of trillions of units of fiat every single year. As the yield on the dollar rises (higher interest rates), the comparison where it has an advantage over its no-yield competitors becomes more favorable to the dollar. Simply stated: Investors determined they would get paid more to hold dollars so they sold commodities and Bitcoin and bought dollars.
Here’s why I’m not reacting to the likely news: I don’t think there’s anything the Fed can do right now. In a phenomenon I labeled Counter-Intuitive Inflation and which Lyn Alden has called Fiscal Dominance, the real driver of interest rates right now is an over-spending Congress. If the Fed cuts the overnight rate, the bond market will price in higher future inflation. If the Fed increases the overnight rate, the bond market will see that higher future interest expense will need to be monetized, something that causes higher future inflation. As long as Congress overspends by trillions a year, we’re going to have higher future inflation. That will be the case regardless of who the Fed Chair is and what the fed funds rate will be.
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