The return of the devaluation trade | Without a bank

The return of the devaluation trade | Without a bank

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If you haven’t seen it yet, Bitcoin made a violent move today, dropping around 6% to above $68,000 at the time of writing, exploding over $68,000.1 billion short films along the way.

Most cryptocurrencies moved alongside it (notably ETH), while gold and silver also ripped apart. Meanwhile, long-term Treasury yields fell, the dollar weakened and stocks barely moved.

In short, it is a behavior which announces the return of the loved one. depreciation trade: buy durable assets when investors believe that policymakers will eventually tolerate inflation or currency weakness to keep the economic machine running.

This decision did not come out of nowhere. The catalyst was a Treasury announcement that it will at least double the amount it can repurchase in each transaction for certain 10- to 30-year Treasury bonds, from $2 billion to at least $4 billion starting September 9.

Why do they do this? OfficiallyThe Treasury wants to make these longer-term bonds easier to buy and sell and reduce the risk of turbulence in this part of the market. The main reason traders care is that long-term yields have remained high while inflation persists, government borrowing increases and investors demand more compensation for lending money to the government for decades. In fact, the 30-year yield has reached its highest level since 2007 just yesterday.

This is important because Treasury yields set borrowing costs across much of the economy.

When investors demand a higher return for holding government debt, borrowing becomes more costly not only for Washington, but also for businesses, home buyers and large investment projects.

Although Treasury asset purchases won’t solve this problem, government intervention sends a message to Wall Street. The message indicates that officials are ready to step in when tensions in the bond market start to get uncomfortable, or so the market believes. In other words, they will tone it down.

If you’ve been on Twitter today, you may have seen many calls that this is the much-coveted “QE,” or quantitative easing.

Today, there was no quantitative easing. Simply put, QE is when the Fed creates new money and uses it to buy bonds, thereby injecting more liquidity into the economy to spur growth and generally helping to drive down yields along the way.

This did not happen today. The Treasury buys back some of its own existing bonds while continuing to issue debt elsewhere. No new money is created through this program.

But what matters is what today’s decision might imply about the direction policy takes next. If bond market tensions worsen, traders now see a greater chance that authorities will intervene again, potentially through larger liquidity injections or, ultimately,…QE.

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Why would policymakers lean this way? The consensus theory revolves around two dynamics: the race for AI and Japan.

Start with AI (which Felix at Blockworks did a great job covering). The U.S. government explicitly views AI leadership as a matter of economic competitiveness and national security, and the infrastructure race is extremely capital-intensive. The Treasury estimates that AI-focused investments accounted for about half of the US GDP growth in the first quarterwhile Total real GDP increased by 2.1%.

Higher rates make this construction more expensive, giving policymakers more reason to keep borrowing costs from soaring and stifling investment. They don’t want that.

And then there is Japan.

Japan is the largest foreign holder of U.S. Treasuries, with about $1.12 trillion in Junewhile its own bond market is under pressure and the yen remains volatile.

The problem is quite simple. Rising Japanese yields make it more attractive for Japanese institutions to keep money at home, potentially reducing their appetite for U.S. Treasuries. At the same time, if Japan needs to support the yen, one way to do so is to sell dollar assets, including Treasury bonds, and use those dollars to buy yen.

As The Forward guide explainsif Japan were forced to aggressively sell its Treasuries, bond prices could fall and U.S. yields could rise, thus exacerbating the same borrowing cost problem that America is already grappling with.

Neither Washington nor Tokyo want such an outcome. Traders therefore expect the two governments to look for ways to stabilize the yen and the Japanese bond market without forcing a disorderly sell-off of U.S. Treasuries.

The simplest way to think about it is that policymakers face a trade-off. They can continue to fight inflation at all costs and risk letting high borrowing costs weigh on markets and economic growth, or they can intervene to ease this pressure and accept additional risk of inflation or monetary weakness. Today’s announcement has traders increasingly betting on the second option.

And if this means more liquidity will enter the system in the future, investors have another reason to flee to assets whose supply cannot simply be expanded, bringing us full circle on the devaluation trade.

We will get more evidence in the coming months from the Treasury, the Fed and Japan on whether this policy direction really is sustainable. The devaluation narrative overheated last year and early this year, but the underlying tension has not gone away: huge debt, persistent inflation and strong incentives to keep borrowing costs from rising enough to threaten markets or strategically important investments.

But for today, enjoy the green. I hope you were positioned accordingly.

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