Depreciation, Fed, And Brexit

The currency depreciation story has been gaining steam, leading to a surge in my favorite investments of gold (+23% YTD) and bitcoin (+77% YTD). Neither has a great correlation to inflation, they're more like psychological bets that investors will try to ditch their government-issued currency. I expect both to continue doing well, and I'm maintaining my large exposure to each. If you don't own any cryptocurrency, I'd still strongly suggest buying some (mostly Bitcoin, a little Ethereum and DASH). You haven't missed the boat. This is just the start of the birth of a new asset class. The crypto world is a complex beast for the uninitiated - I'm happy to chat about it if you'd like more information.

Last week's Federal Reserve meeting had a few major surprises. While the interest rate was (unsurprisingly) unchanged, the Fed issued very pessimistic forward guidance on the economy, and substantially reduced their expectation of future rate hikes. Additionally, the St. Louis Fed. led by James Bullard, released an entirely new policy framework for how to think about the economy and how the Fed should manage interest rates. To oversimplify - rather than focusing on a single base case economic scenario, Bullard thinks the Fed should focus on a range of possible outcomes and the uncertainty around them. In other words, just because unemployment is very low today, he advocates dovish policy because of things that could go wrong in the future. This shift towards dovish Fed policy will further support the currency depreciation theme.

While the "inflation hedging" assets have rallied strongly, actual inflation expectations (represented by the inflation swap market) are only up slightly. Unemployment has fallen to 4.7% and money printing continues in most countries, but investors feel that deflationary forces are even stronger. That strong unemployment number hides a falling labor force participation rate. Even China is starting to replace human labor with robots on a massive scale. Long-term we'll continue seeing deflation in commodities and input prices, and inflation in the cost of final goods as a result of currency depreciation.

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