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- [00:00]
A
Back for the 10:31 timestamp recap, I'm joined by the real John Arnold. John, how was your weekend?
- [00:07]
B
As good as it can be when you're four weeks deep into a military mission with World War 3 level implications and an uncertain timeline beyond that, it was, it was good. You have to stay off the timeline on the weekend. Never doom, touch grass.
- [00:21]
A
Never doom. You go to Palm Sunday Mass.
- [00:23]
B
Exactly.
- [00:24]
A
Anchor yourself in what's going on, what's really important. Then we can come here Monday and reconvene and talk about the big thesis that you really touched on in the newsletter over the weekend, which is there's a lot of discussion about the Federal Reserve and whether or not they're going to hike. Probabilities across the board seem to be pointing at an increased chance of the Fed hiking at the end of this year. But you're drawing a line and saying no, you don't think they can. Why are you drawing this line?
- [00:54]
B
Yeah, I mean to some extent this week's newsletter is the result of me being tired of schizoposting about different things that could happen in the straightforward news and I feel like everyone started reading about that. So I tried to take a bit of a different tack this time. But I actually think this was maybe one of the more interesting and underreported stories of last week as everyone stays focused on minute to minute updates out of Iran. Yeah, as you said, market increasingly looks to be pricing higher odds and at one point late last week basically coin flip odds of at least one if not rate hikes by the end of the year. You can see that on the chart here. This was taken from the CME Fed Watch tool and this is in response to an assumption, probably correct assumption, that the amount of time that the straight up movements has been closed and the amount of disruption that's happened to global energy markets just in the last month, again, even if everything ended today, that's going to have bullwhip effect and flow through to inflation and that'll put the Fed in a position where they actually have to hike rates and get more restrictive and less accommodative to combat that. And you can see that being priced in somewhat here in Fed funds futures. If you were on Fintwit at all over the last week, if you've been reading any mainstream financial press that this is a headline you're seeing trumpeted about a lot, I have no idea, as I said in the newsletter, what different transmission mechanisms look like, what the Fed may be able to do on creating different Alphabet soup facilities to offset a potential rate hike. But the general gist that I was putting out in the newsletter this weekend was drawing a line on there's less room than the market thinks given the fiscal state of the US Particularly if we're going to, in Secretary of War Pete Hegseth's words, allocate another $200 billion to kill bad guys on an already massive federal budget. Given where we're sitting with non discretionary spend as a percentage of receipts, we can't have blended interest rates, blended interest expense on federal debt much higher than they are today.
- [03:02]
A
Right.
- [03:02]
B
And you can see that. And if you flip to like I'll just flag the chart on page four, we've talked about it a bit on the show previously a couple months ago, but it doesn't take a ton of crazy math to realize that that's the case. And yes, here just shows we're already kind of bumping up on the ceiling and you go much higher and you get into pretty bad territory pretty quickly, assuming you don't have ability to make meaningful cuts elsewhere in these non discretionary items. And I just think that's for many reasons politically untenable and not going to happen, especially in a world that's getting much more multipolar. So that puts us in kind of a rough position already. If you flip back though to slide two, perhaps even more immediately concerning is the move index is now getting squirrely. So this is kind of comparable to the VIX for strategic volatility. And we're now back to levels that we were seeing at Liberation Day last year. And this is a big problem by itself even outside of the multi year kind of projections on federal interest expense. Because if you flip down to page three, we talked about this chart in the newsletter in previous months. But increasingly there are a lot of levered hedge funds that are deep in the treasury basis trade. You can see in that bar how much net issuance has been absorbed by such hedge funds as well as other foreign private actors, which can mean a lot of different things. There's a good amount of volatility sensitivity in those groups, right? They get the tap on the shoulder when regardless of the level of the 10 year yield, as volatility picks up and then it flows through to equity market volatility. There's a quick reaction function to DeGross to sell positions to go to cash and that can quickly turn into a vicious cycle on the most important bedrock asset in the modern financial system. And so there are all these kind of factors conspiring that basically to me point to regardless of what happens with inflation and printed inflation, the Fed does not have the leeway to get substantially more aggressive or more restrictive across its different facilities and different tools on the treasury market and on rates. So as I said in the newsletter, we're far from rates traders. I'm not making any kind of forecast on where anything's going month to month or quarter to quarter. But I think broadly that's a theme that I would fade as we go forward this year, that the Fed's just going to practice fiscal rectitude or try to impose fiscal rectitude on the country and just respond mechanically to higher inflation with higher rates.
- [05:40]
A
Well, you said it in the newsletter. To anyone who believes the Fed can't be accommodative for fear of inflation in the face of commodity shocks, your grandparents might beg to differ. I think another parallel that people are looking at right now is the 1970s oil shock to today. But I think as you just described, if we're looking at all the debt and specifically the debt to GDP ratio that exists today in the United States compared to, then it is far different. And then we've been talking about it. Who knows how systemic the private credit sort of contagion becomes. I think it's yet to be determined. I think there's other funds. I believe Morgan Stanley gated a fund, a private credit fund last week. It does seem like there are analysts out there who aren't worried about contagion breaking containment of this sort of retail oriented private credit vehicle or these BDCs that exist out there. But who knows, maybe it does break containment. You do have a systemic contagion that triggers a domino effect of liquidity crunches within the financial system. And that's sort of been my MO Observing this and looking at people saying they're going to rate, they're going to hike rates. Excuse me. Obviously this disruption to oil and gas global supply chain infrastructure is massive. But I think there's just going to be forces, whether it's the war itself or a potential liquidity crisis in the back end of the financial system here in the US that spreads globally. That's going to dictate the Fed needing to be more accommodative.
- [07:12]
B
Yeah, right. That's a great point. It's certainly like there's debate right now on how relevant the private credit complex is the overall system, it's its relative size, its overall leverage, and perhaps it's either not going to perform as poorly as some predict or even if it does, that has less relevance than poor performance of the major commercial banks leading up to 08. So that may or may not be the case, but certainly you could say it doesn't help, right? So any kind of massive squeeze in any pocket of levered pocket of the economy is not going to be received well. And we've seen not to compare the private credit complex to say svb, but SVB was a large bank, but not a bank that a lot of people even heard of. Probably in the US it was top 20 by assets. But in a couple days very little needed to happen for that to become the most important story in financial markets and something that the Fed had to aggressively respond to. The parallels largely in there. Private credit is not the same as banking. But my point is just in a very challenged environment anyway, the last thing you need is a cascading daisy chain of liquidity crunches in those types of vehicles. And I think that will pile onto if that really escalates and accelerates in the coming months, that piles onto the things that the Fed has to further respond to. And I think it's really like the thing I was thinking about over the weekend was in a shock. It's often said correlations go to one everything just people. There's a scramble for liquidity, there's a scramble for dollars. You often see the Dixie, the dollar index RIP when everything else is dumping in crisis environments as people just kind of scramble for some level of certainty and kind of get out of whatever they can. They sell what they can, not what they want. And I think there's an element that people need to start thinking through which we haven't really seen in the last 50 years, 50 plus years of correlations going to 1 in government policy as well. There's this view that the Fed and the treasury and Congress and different state governments and the military are all kind of these different organizations that have their own priorities and their own ways of operating. And definitely in peacetime, I think that's very much true as, as you move into a higher and higher volatility environment, both in terms of the financial markets, but also just globally and militarily, I think you see correlations go to one in all government institutions as well. And I think this was what I was referring to in the newsletter with the way that your grandparents might beg to differ about what the Fed can and can't do. If you go back and look at say people talk about the 70s, like you said, I think the 40s is an equally interesting, if not more interesting Kind of analog where you had radically expanding debt to GDP and Fed and treasury direct coordination to make sure that that wouldn't flow through to treasury yields and spike treasury yields. And you could normally. And you would say well that would just spike inflation. Right? We couldn't possibly do that again. Well the way that that was managed right in the 40s was price controls and rationing.
- [10:09]
A
Right.
- [10:10]
B
A huge amount of goods were subjected to with consummate US propaganda. You got to love the vintage propaganda here. Subjected to rationing cards and anti hoarding measures for a wide variety of consumer goods. I think you literally saw the analog of cpi. I don't think it was CPI at the time, but we went from early 40s, CPI was double digits, I think 14% between 10 and 14% and then fell, reported CPI fell to 1% because you weren't actually seeing inflation. But no one could get anything or not meaningfully, at least in the consumer economy. And then once those were released you saw reported inflation spike back up to 15% in 19. But all the while the 10 year was at 2 and a half percent the entire time even as debt to GDP went from 50% to 120%. And so I think it's just worth thinking through. I don't even know if we could actually functionally do that today. I don't know if we have the political will, the political unity. Nor am I calling for this, nor do I think it would be a good thing for any of us to experience. But I think it's just important as you're positioning yourself to realize there are times in history when correlations go to one in governments and, and that means the Fed and the treasury and Congress and the military are all going to be very aligned on what needs to happen. And I think his book Freedom's Forge is a great one to look at. It's less about the rationing and kind of price control side, but more about the complete industrial remaking of America in just a couple of years to respond to the European and Japanese theaters up to World War II. And we went from being extremely industrially unprepared to very, very prepared in just a few years with massive mobilization and government control of industries. Again, not recommending that necessarily there are meaningful downsides to that. But I just think this is the kind of thinking that the market is not yet really doing. And I think people price it at a zero percent chance. And I think we're getting into a position where this is like 10%, 20%, 30% type odds that you need to be thinking through on the scenario tree.
- [12:11]
A
Yeah, I mean, it's funny that the market isn't beginning to even price in a low probability of this coming in. Because you've been covering in the newsletter, we've talked about it too. But this light nationalization or industrialization of certain industries that we've seen from the Trump administration going back to last year, buying stakes in heavy metal companies, in industrial metal companies and energy companies, and a range of different companies that may prove to be integral in a re industrialization during a wartime effort at some point in the next six months, potentially, if things don't turn in the other direction towards more peaceful reconciliation to what's going on in the Middle East.
- [12:53]
B
Yeah, absolutely. And I mean, you're seeing if you flip to the next slide, we highlighted some headlines from this past week. But the unfortunate thing is you're seeing this already, versions of this already in parts of the world that many of which are actually our allies, the Philippines, South Korea, Australia. This is already starting to bite in a variety of different ways. And there's been some good writing out there that we flagged in the newsletter this week as well about the downstream impacts on a wide variety of commodities and refined goods that are maybe one level up from base inputs like oil. It hits everything in a variety of different ways that we're not even currently expecting. And you're already seeing governments respond exactly as governments always do in this case. And so, yeah, I think we should be probably we being the U.S. if you're listening from the U.S. the classic dark joke, I guess, is that the U.S. sneezes and the rest of the world gets a cold. So there's some level of insulation for a net energy exporter that's relatively independent on food supply, although there are asterisks on that as well. The US should probably fare better than a lot of US allies, but the reality is it's flowing through already everywhere, even in places that are nominally allied with the U.S. so, yeah, I think the market should increasingly be pricing in that. Something like this would be a response that we would see here as well. Yeah.
- [14:09]
A
And tying this back to the core thesis of this newsletter being that the Fed cannot hike rates and they're probably going to have to be more accommodative than people expect right now. This should be a tailwind for bitcoin, correct?
- [14:23]
B
Yeah, you would think so. I mean, admittedly, the era of rationing, price controls, et cetera, and industrial mobilization was also the era of Executive Order 6102, which famously removed One of the major which was the seizure of privately held gold or the banning of privately held gold under fdr, which famously removed one of the clearest kind of response valves and escape hatches that you would have to deal with an environment like that. I think there are reasons to believe, and we've talked about it before internally, you've talked about it on tftc, reasons to believe that Bitcoin has a greater level of resistance to something like that or the government to try that. But I also think, think the pieces that are lining up right now suggest that that may or may not be the actual path that this administration wants to take. So maybe we can kind of move in that direction because I think we got some really interesting headlines last week about Bitcoin and its increasing integration into a lot of different facets of the economy.
- [15:27]
A
I was going to say off the top of my head, I think probably the biggest announcement was Fannie Mae, Freddie basically recognizing Bitcoin as an asset, I think officially now. And then coinbase launching their 30 year mortgage with better homes, I believe is the company that allows you to put Bitcoin up as collateral for a 30 year mortgage. And I mean I tweeted it out and feel comfortable talking about. I can't say exactly who I got my mortgage through, but I have a 30 year mortgage that is dual collateralized with Bitcoin. And this is something that we've been talking about internally at 10:31. I think you and I specifically have been waiting for this moment within Bitcoin where it becomes a preferred collateral asset in credit stacks, in this case a 30 year mortgage. And I think the most exciting thing about this not only is the validation that Bitcoin is pristine collateral that financial institutions are willing to sort of recognize and engage with for people who have built bitcoin wealth and don't want to sell it, but want to tap into it. But I think the most important thing is duration. Really beginning to enter the bitcoin credit market, for lack of a better term.
- [16:34]
B
Yeah, absolutely. I think the really interesting piece of what really is unlocked by the Fannie news, to the extent that it really continues to roll out, we need to see that there aren't gremlins in the fine print or some effort to stop that, but the ability for those loans to be conforming mortgages that can be purchased by Fannie and Freddie and enter the secondary market brings a whole new level of potential liquidity to those loans and makes them much easier to originate. Right. So you could start to see over time the ability for a lot more dollar financing to come into Bitcoin backed lending and bring rates down as that develops. Right. That's a huge backstop for all these loans and I think a key blocker for the ability for them to really achieve like commercial scale. So that's, you know, I think that's a huge, huge piece of news. It would not insulate you from a6102 type attack obviously to have Bitcoin locked up in one of those highly central loans. But I think what it's telling you is that the government is not currently attempting to discourage but rather to encourage more exposure to Bitcoin ownership. And I think there's an argument that you could say you want more people holding an asset that participates in an upward kind of liquidity impulse if you are indeed going to do a lot of the things that we described, albeit participation via heavily controlled wrappers. But you want broader ownership and broader exposure to that kind of liquidity impulse and an asset that will meaningfully benefit from it. To avoid and curtail political pushback that you might otherwise get, you could take the hammer approach that has been taken in the past or you could kind of take the catching more flies with honey than vinegar approach of bringing people into Bitcoin linked products. And I think that's an interesting confluence at this time as you're seeing more and more need potentially for control of elements of the economy and a more, a more creative relationship between the Fed and the treasury, let's say to have this greater institutionalization of a normalization of kind of Bitcoin oriented financial products.
- [18:45]
A
Yeah, I mean a pressure release valve for the government. Just use this neutral reserve asset that's floating on the free markets. And yes, we're going to go do all these inflationary, we're going to go try to stimulate the economy where it's via the Fed being accommodative or the treasury issuing more debt to support the war effort. Give the people a release valve that will benefit. Whether or not you can get into the ethics of having that there, I would say it's a good thing. But there's an external wealth effect that exists within Bitcoin. If you can integrate it into the traditional economy more and more and it's going to be massive. And so going down this line of thought today as well, I don't know if you covered it in the newsletter, but I think you may have touched on it. But square just making Bitcoin payments automatically, just auto enabling them for the merchants. I believe all the Merchants, except for those inside New York, I would imagine, are the only ones who may not be able to accept Bitcoin as payment because of the bitlicense. I could be wrong there, but Miles Suter, head of Bitcoin product at Block across their family businesses, he was tweeting out earlier today that was going live and they want to make Bitcoin everyday money on top of that. We had some ETF news last week both on the flows perspective and a new entrant into the market. ETF flows are almost flat on the year despite massive volatility, which shows that the market is resilient. And no matter what the headlines are telling you about Bitcoin, despite the fact that it's down 48% from its all time high last October, early November, there is still demand from institutional buyers and people who access exposure to Bitcoin via ETFs to get exposure. And then I think the big news, as Eric Balconis from Bloomberg says, I think it was a bit of a shock. He's calling it a semi shock. Morgan Stanley filed for a Bitcoin etf. It looks like it's going through the approval process rather quickly in other marketing that they're going to charge 14 bips of fees, which undercuts BlackRock's IBIT ETF by 11 bips. And Morgan Stanley doesn't issue that many ETFs and it was very interesting. I think they have maybe 17 or 18. And now the Bitcoin ETF is one of them.
- [21:01]
B
Yeah, I think it's fewer than that. I think it's seven with the actual Morgan Stanley flagship branding and this one will have that. So I think they filed a month or two ago. But the update on what they'll charge is just interesting because I think it tells you that the fees are obviously really low already. So it's not like they had a huge amount of cushion if they wanted to be competitive. But to go meaningfully lower than ibit, I think suggests something interesting about what they view as strategically valuable here and how big they believe the AUM opportunity of this could ultimately be, and how much demand they are likely seeing from the Wealth Channel. To get this out there, to put it under again, the flagship branding, and then to price it so much lower to make sure that advisors, as Eric says, are not conflicted and feel comfortable channeling clients into it. Not trying to just price with IBID and go for slightly higher fees, but actually price meaningfully lower and just gather AUM into the vehicle. I think that's Telling you something about especially seeing that in the middle of this environment, like you said, where we're 50% off all time highs, a lot of mainstream interest has moved on to other things. This is not the kind of thing that we saw last time we had had price action like this, particularly in the middle of everything that we've talked about earlier on the show with semi World War III beginning. So that you would see something like this in this kind of environment is I think very telling. And again does not to me point in the direction of a government that wants to outlaw or avoid people channeling wealth into bitcoin. And again, we can debate what the best way is to do that and the vulnerabilities that come with doing that through an etf. But in any case, this happening to me, all of these things happening points in a very different direction than we might have been headed in just a few years ago.
- [22:55]
A
Go, yeah, it seems like just build the paths for people to get on the lifeboats as we do this crazy stuff on the re industrialization and the wartime footing. As an American it's like okay, at least this stuff is happening in the background. Stuff that I care about, stuff that we focus on. It's good to see to your point. Mitch is just sort of reiterating of my point, but I think it should be reiterated more and more as the this happening in this type of price environment is very unique in terms of the tenor around Bitcoin right now is honestly pretty piss poor if somebody has been in it for 13 years. Almost reminds me of 2015. 2015 was I think the worst from a sentiment perspective that I've ever experienced. These last six months are very close to that. But the fact that we have Fannie Mae, I'll just pull the headlines up here too. Accepting the first crypto backed mortgage products. We have Morgan Stanley putting their name on it. We have block enabling, auto enabling of payments and ETF flows. If you were just looking at pure flows with no knowledge of what the price is doing, you'd probably think the bitcoin price has been flat for the last six months, but it hasn't been down 48%. Long way to go John. Any final thoughts before we wrap up here?
- [24:15]
B
Just got to stay humble in sac sats and fade every 20 tweet from or every true social post from our President and fade every response from the Iranian parliamentary members that are firing back at him on Twitter.
- [24:28]
A
Yeah, the meme warfare reaching the levels that it has. We've got Lego AI generated videos. We've got true social posts in the morning tweets. It's crazy times. We'll be back next week.