“An expert is someone who knows some of the worst mistakes that can be made in his subject, and how to avoid them.”
- Werner Heisenberg

The main event on the calendar for economic indicators, U.S. non-farm payrolls, came in at +263,000. The consensus forecast was for an increase of 250K, amounting to a miss of +13K payrolls. The knee-jerk reaction in financial markets was a selloff of more than 2% in major stock indices and a modest rise in bond yields. Crypto remained remarkably steady with BTC holding above $19K, ETH above $1.3K and BNB above $280 despite a coordinated chain pause after a bridge exploit.

There were more sellers than buyers in the stock and bond markets. The New York Times stated the reason for this price action thusly: “… fresh data about the health of the labor market in the United States solidified investors’ expectations that the Federal Reserve will need to keep raising interest rates to lower inflation.” That is the dominant narrative, and a sensible one, although perhaps a little too confidently articulated. The good-news-is-bad-news reflex is alive and well!

But is the market really that sensitive to a 13K payrolls miss? Maybe. But over the last few months, it has looked like the market is reacting to the raw numbers as opposed to the seasonally adjusted headline. As shown below, the raw payroll number for September was an increase of 431K, a stronger signal of a robust labor market.

In any case, there are many on the Federal Open Market Committee (FOMC), including Fed Chairman Jerome Powell, that have repeatedly cited the U.S. labor market as an indicator of an overheating economy. Yet non-farm payrolls have only recently regained pre-pandemic levels despite a population increase of more than 2 million. A greater population with similar payroll numbers means a proportionally smaller labor force, and that is revealed in the statistics. The Labor Force Participation Rate is a full percentage point lower than in January 2020.

One percent of the estimated U.S. population of 332,403,650 equals more than 3 million fewer workers earning a paycheck than should be compared to January 2020 equivalent levels.

The labor market is not a strong now as it was in January 2020. After two quarters of GDP contraction, the economy is in a “technical” recession and is certainly not as strong now as it was in January 2020. And yet the Fed is raising rates to curb inflation, citing a strong labor market and an economy that is running hot.

We can see the CPI readings are higher than January 2020. Everyone blames the Fed, and it appears that the Fed is sensitive to that criticism. But if the Fed’s policy rate was appropriate in a stronger economic environment in January 2020 at a level 150 basis points lower than today, it seems relevant to point out the contradictions in aims versus policy. The Fed was not responsible for $50 WTI and $2 Henry Hub natural gas in January 2020, nor a smoothly running supply chain. It is not going to “fix” those inputs to the CPI now with interest rates.

You Actually Listened to Those Speeches? Get a Life!

The Fed is nonetheless intent on signaling a hawkish stance. In a speech on Oct. 5, Atlanta Fed President Raphael Bostic was talking tough:

“You no doubt are aware of considerable speculation already that the Fed could begin lowering rates in 2023 if economic activity slows and the rate of inflation starts to fall. I would say: not so fast.”

The next day, Fed Governor Christopher Waller said in a speech “… I've read some speculation recently that financial stability concerns could possibly lead the FOMC to slow rate increases or halt them earlier than expected. Let me be clear that this is not something I'm considering or believe to be a very likely development.”

I must repeat; the market does not believe them.

Fed Funds futures are still predicting the policy rate to top out at a little over 4.5% in June of 2023 and rate cuts to ensue before the end of the year. I wonder who Werner Heisenberg would bet on being right about the Fed policy rate: the market or the Fed itself.

The Purchasing Power of the Euro Dropped 43.3%?

Non-farm payrolls were the main event and moved markets, but the week started with a little news from Eurostat. The EU Producer Price Index (PPI) for August came in at an annualized 43.3% increase. It is difficult to fathom what that means to operating margins for businesses in that environment.

But the German benchmark DAX index of 40 blue chip stocks actually rose on the release and the yield on the German 10-year benchmark bond ended the week at 2.19%. The eye-popping PPI release was not a surprise, given the disruption in energy markets related to the war in Ukraine. I guess the markets have even more faith than I do that European bureaucrats will do something to mitigate the pain.

To the Rescue!

European bureaucrats did in fact do something this week! The Markets in Crypto Assets (MiCA) draft regulation was released by the European Parliament and European Council.

At 380 pages, it is an ambitious attempt to fit crypto into a regulatory framework. The draft MiCA text reminds me of similar work inspired by the Great Financial Crisis of 2007. Not quite as much of a tome as the 849-page Dodd-Frank legislation, it is similar in that it is long and dense, and loaded with 77-word sentences like:

“In order to enable supervision, offerors and persons seeking admission to trading of crypto assets, other than asset-referenced tokens or e-money tokens, should, before any public offer of crypto-assets in the Union or before those crypto-assets are admitted to trading on a trading platform for crypto-assets, notify their crypto-asset white paper and, upon request of the competent authority, their marketing communications, to the competent authority of the Member State where they have their registered office or a branch.”

I guess this should be expected as it is legislation. But it ensures that only those with legal training and the patience of a farmer will be able to interpret it competently. I am not sure how many degenerate yield farmers are going to be open to reading it.

The draft bill is up for approval by the European Parliament on Oct. 10. Should it be approved, crypto-focused companies and individuals will have 18 months to prepare for compliance.

The MiCA draft was too long for me to read (I have a life), so instead, I read the 124-page Report on Digital Asset Financial Stability Risks and Regulation, released this week by the U.S. Financial Stability Oversight Council (FSCO) and a related 31-page report by the Federal Reserve Board titled “The Financial Stability Implications of Digital Assets.”

These reports were basically calls for crypto legislation to be taken up by Congress.

Of course, there were things in these reports for newsletter writers to poke fun at, such as:

“… financial stability risks from (stablecoins) and the amplification mechanisms of such risks through vulnerabilities in the crypto ecosystem are hard to gauge, as information is poor and regulation and supervision are weak.”

As if using a block explorer is that hard, and the info, regs and supervision in TradFi did such a great job on LTCM, the Madoff Ponzi, the collapse of Bear Stearns and Lehman Brothers, et al.

Confronting the opportunities for regulatory arbitrage was also mentioned as if there is nothing to look at in the activities of Apple, Google, and others in Ireland, or the more than 100,000 companies set up in the Cayman Islands.

But like MiCA, both reports were impressive from the standpoint of the general competence of the authors in discussing the crypto ecosystem. And they demonstrated an awareness of the movement of TradFi players in the direction of crypto by pointing out Soc Gen’s application for a DAI loan using a tokenized bond issue and JP Morgan’s interest in tokenizing U.S. Treasury securities. They also noted the seriousness of banks' commitment to the space, mentioning a study that estimated crypto-related investment to be as high as 1.5% of Tier 1 capital.

Judging from these reports, the last few congressional hearings on the subject, and the crypto credentials of many bureaucrats charged with overseeing the space, I am hopeful that appropriate legislation will be the result.

It probably will not be any easier to read than MiCA or Dodd-Frank. But without it, this world-changing technology will not reach its potential.