Translation: BitMEX research team takes a pessimistic view of the market: Don't wait for the end of inflation.

The BitMEX research team released a new article on the 21st, titled "Don’t Wait For The Inflationary Endgame", discussing the impact of stacking inflation after interest rate hikes and taking a pessimistic view of the future. Here is a summary of the article. For any uncertainties, please refer to the original text.

Summary: This is a follow-up report to the March 2020 article "Inflation Is Coming." Inflation rates have reached their highest levels since the early 1980s, and the Federal Reserve will have to tighten liquidity conditions in response. We believe this inevitable liquidity tightening will have a significant impact on consumer prices, leading to a decrease in inflation rates. However, in the long term, unstable inflation conditions during intervention will make it difficult for investors to find the right path, with inflation ultimately emerging as the winner.

Inflation is Here

Various underlying factors have led to a remarkably high inflation rate. Regardless of how you view and weigh these factors, such as a series of specific supply chain issues post-Covid-19 or the monetary and fiscal policies in response to Covid-19, we are all facing the same situation. Inflation is here and at its highest point since the early 1980s. The Federal Reserve must respond, and they will.

Rate Hikes Will Have Significant Impact

Some readers have requested updates since predicting the arrival of inflation post-March 2020. We believe the Federal Reserve will taper quantitative easing and raise interest rates. Yes, we believe this shift will have a significant impact on financial conditions. Therefore, the inflation rate in 2022 may decrease. However, this view is not a collective consensus, at least not among Bitcoin enthusiasts, gold bugs, extreme gold bulls, and those expecting inflation in 2020.

Take the prominent U.S. stockbroker Peter Schiff, for example. He may be the world's most enthusiastic and frequently mentioned high inflation predictor. He questions the impact of raising rates to 2.5% on the economy and inflation.

"The highest I've heard is 10 rate hikes... But 10 doesn't mean anything! Assuming all hikes are 25 basis points, after ten, rates will be at 2.5%. At that point, inflation will be at most 7.5%, with a negative real rate of 5%, a 5% negative rate cannot combat inflation. There is no history to support this, it's impossible, and it contradicts any type of economic school. If the Fed raises rates 10 times, 25 basis points each time, to 2.5%, the real rate will be far below -5%, because by then the Consumer Price Index (CPI) will be at least 10%, or even more!" Peter Schiff expressed his views on his Youtube channel.

We do not agree with Peter's view that even with negative real rates, a 250 basis point hike to 2.5% will have a significant impact on the economy.

Financially Unbearable

For decades, investors and the financial system have been accustomed to declining rates. In some ways, the prevailing belief is that rates will remain low forever. Investors react to this environment by pouring into stocks and equity commodities, often using leverage. Additionally, the pace of a hike from 0% to 2.5% is different from that of 2.5% to 5%. Investor behavior is convex, and the impact of a hike from 0% to 2.5% on asset allocation and investment flows may be much greater than from 2.5% to 5%.

Investors consider the nominal rate, not the real rate. Regardless of how economic theory explains the impact of negative real rates on inflation, structurally, the market cannot tolerate higher nominal rates.

Note: Nominal Interest Rate: Generally referred to as the market rate or monetary rate, is the rate without considering inflation factors, such as bank deposit rates or bond coupon rates. Real Interest Rate: Also known as the natural rate, is the rate after deducting the inflation rate from the nominal rate, reflecting the currency's real purchasing power.

Therefore, we expect that a rate hike will have a significant impact on investors' demand for financial assets, including stocks and cryptocurrencies. In the current environment, investor flow is king, not fundamentals or valuation ratios, so the impact will be significant.

Meanwhile, the so-called real economy has largely crumbled. Artificially low rates have stripped economic fuel from real, sustainable, profitable, and modest companies. Instead, we are left with loss-making tech startups, dominant venture capital funds, meme stocks, CryptoPunks, and metaverse real estate.

This represents an extremely high level of financialization in the economy, and highly financialized industries and any companies that rely on them may be heavily impacted by tightening financial conditions. The relevance of these industries to political economy is stronger than many analysts predict. In what we have left, they are very sensitive to fund flows and liquidity conditions. Tightening policies will have an impact on consumers, and we expect it to lead to a decrease in the official inflation rate.

Policy Responses

Of course, authorities will respond to economic recession and eventually return to the inflation mechanism. However, this may not be as simple as some expect. After the rate hike, authorities may not be willing to easily lower rates again. Broad loosening of monetary conditions may not be politically welcomed, instead, responses may be more targeted and coordinated monetary and fiscal stimulus measures.

Therefore, the next wave of inflation may first appear in consumer prices rather than financial assets. But financial assets will experience significant lag and volatility.

How to Position Yourself

Quietly waiting may be an enticing approach. The ultimate winner will be inflation, as long as you quietly hold inflation-hedging assets. After all, your portfolio of Bitcoin, Ethereum, gold, and index-linked bonds will ultimately beat inflation.

However, we do not recommend this approach. This game may last five to ten years. But during policy interventions, inflation may fluctuate, meaning the CPI may decrease at certain times. With declining inflation, only a few investors have the patience and resilience to stick to this argument.

Attempting to use strategies and calculate market cycles is often considered quite foolish. The current popular saying goes, "Passive funds and algorithmic strategies make active fund managers and stock pickers hesitate," it's time to shut down the machines and sell the index trackers, you will have no choice. Remember to buy Bitcoin at $20,000 and enjoy the game.