Good Morning. Government bond yields fell further yesterday, sending a grim and increasingly familiar message about growth in the coming months. But the headlines have been dominated by crypto. A few words on this and on rental price inflation below. Email us: email@example.com and firstname.lastname@example.org.
Why Tether snapped
A sudden and brief tumble in the price of the stablecoin Tether – which came just like virtually every other cryptocurrency that sold off hard – gave everyone a minor heart attack yesterday:
A tether wobble is of concern because it is – theoretically – pegged one-to-one to the dollar through a bunch of fiat assets. Like a country defending its currency from devaluation, the issuer company (Tether Limited) can buy Tether tokens with fiat money to prop up the token price.
However, the pin is frayed before that. During the “crypto winter” of 2018, Tether traded at just 91 cents for several days. But it rallied, and the episode helped solidify the belief that while crypto is volatile, it is resilient and ultimately going up. Crypto enthusiasts have assured everyone that this recent sell-off is a repeat of 2018.
However, Tether Limited refuses to fully disclose the fiat assets it holds, making it impossible to gauge the resilience of the tether. Regulators fear a wave of mass redemptions for Tether and its peers – an old-fashioned bank run. A run on Tether would be particularly dangerous as it is fundamental to the overall liquidity of the crypto market. It is the primary medium for switching back and forth between crypto assets and dollars. Its failure could bring the entire crypto ecosystem to its knees. As one of the founders of dogecoin put it“If Tether dies, it’s all over, friends.”
Worries were compounded by the fact that another cryptocurrency, TerraUSD, also melted this week. Although TerraUSD also bills itself as a stablecoin, it has little in common with Tether other than aiming to be worth $1. Rather than being backed by dollar assets, it is an “algorithmic stablecoin.” Here’s how his peg works—if you want to call it that—:
Terra has a counterpart cryptocurrency called Luna.
A system of smart contracts allows traders to exchange $1 Luna (at market rates) for a single Terra Token, or a single Terra Token for $1 Luna.
Arbitrage kicks in.
If Terra is overpriced at $2, buy a Luna for $1, trade it for a Terra, and sell your Terra for $2.
If Terra is undervalued at 50 cents, buy a Terra for 50 cents, trade it for $1 Luna, and sell your Luna for $1.
So if there is enough buying and selling, Terra should stay close to $1.
It seems like a house of cards because it is. The system relies on an active market, which in turn requires traders to believe they are not stuck and holding the bag. If everyone gets mad at TerraUSD at once, the whole thing crumbles. The fragility of this system has long been apparent to close crypto watchers. Here’s Nevin Freeman, co-founder of the stablecoin Reserve, predicting exactly what just happened 2020:
I think that’s the biggest risk [for] Stablecoins is when there is an algorithmic stablecoin that has no backing that only has an algorithmic mechanism designed to keep it stable. . . . One of these could be introduced and marketed very effectively and adopted on a significant scale. . . . If this protocol then explodes economically and the price drops by half or almost to zero, [you could have] regulatory backlash.
Yesterday, the bad sentiment from the TerraUSD fiasco led to selling pressure on Tether, although the underlying mechanics are very different. So far, Tether has defended its bond. But the whole mess has drawn attention to the spillover effects for traditional markets. There was speculation yesterday that a crypto meltdown could ruin retail investor sentiment, lead to a flight from stocks, trigger a rally in safe havens like government bonds, or destabilize short-term funding markets.
We do not know what will happen, but the danger cannot be dismissed out of hand. Stablecoins have a total market cap of more than $150 billion. If all the pins break — and they might — there will be ripples well beyond crypto. (Ethan Wu)
Real Estate, Inflation and the Fed
A refrain that’s been heard frequently in Wall Street commentators in recent weeks is that the Fed can’t control inflation unless it can control house prices and rents first.
In a sense, this is tautologically true: rent and owner-equivalent rent (OER) account for more than 30 percent of CPI inflation and 40 percent of core CPI inflation. When these two are locked in a rapid rally, the Fed is fighting a losing battle.
It’s also true that CPI measurements lag behind private sector rent indices for the simple reason that private sector measurements only account for spot rent increases (the increase that occurs when a tenant signs a new lease on a property ). But rents typically increase annually or more infrequently, and CPI measures look at a mix of new and existing leases, causing lag. Recent academic work puts the delay at around 16 months. The rental inflation we’re seeing in the real world now — 17 percent year-on-year, according to Zillow — will show up in 2023 and 2024 CPI inflation (more here).
It’s also true that house prices are still rising rapidly (by about 20 percent, although the data is a bit dated) and house price increases are generally followed by rent increases. With housing supply so tight in the US, the higher mortgage rates we are now seeing could only slow, but not stop, further home price increases. So it could look like we’re locked into unusually high rates of inflation for the months and years to come, and there’s little the Fed can do.
But the picture should not be quite so bleak. Two points are particularly worth mentioning.
The first point is simple and methodical. The owners’ equivalent rent is not directly related to property prices. It is not accomplished, as is sometimes assumed, by asking homeowners what they would charge to rent their home. Rather, it is based on surveys of actual rents for similar properties.
Second, recognize that the Fed cannot lower rents primarily by raising mortgage rates to lower house prices, thereby lowering rents. Most people don’t borrow money regularly to pay rent. The rent comes from wages. Therefore, the Fed’s ability to change the cost of borrowing does not directly affect rents.
But it affects it indirectly. When the Fed tightens financial conditions, companies spend less, including on wages. And that explains why rents are more directly and closely correlated with wages than house prices. Here’s a chart by Skanda Amarnath at Employ America that plots CPI rent and OER against a broad measure of wage growth:
The point here is that if the Fed can get wages under control, they can probably get rents and OER under control as well. Yes, there will be a lag, but ongoing house price inflation and housing shortages shouldn’t prevent the Fed from bringing headline inflation under control – provided it can dampen headline demand and hence wages. As Amarnath said, all we need is slower job growth, slower wage growth and time to get housing costs under control.
A good read
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Source: Crypto News Austria