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digital daily: Awakening

There is great fear of repeating the 1970s. With inflation overshooting, the only credible way to bring it into alignment is to keep tightening policy until inflation falls. Thus, the recession needs to be deeper than would otherwise be the case. This is the logic dominating current thinking. Yet, data tells a different story. Yes, trailing inflation is high, alarmingly so. But it is also expected to collapse. A strong US dollar and deflating US dollar asset prices is hardly a signal of inflation fear. US CPI is discounted to decline to 2.75% in 2023, and to 2.43% over the longer term. Markets are not questioning central bank’s credibility to fight inflation. Instead, the credibility gap is on economic activity, centered on real interest rates. One-year forward real rates are 1.96% and terminal real rates are 1.20%. Both are materially higher than forward policy guidance. Interest sensitive segments of the global economy are weakening dramatically in response, led by housing. The market judgment is clear. Policy is left with the difficult choice to avoid a much deeper, prolonged downturn by accepting higher inflation. That is the decision-set ahead – policy is chasing the ghosts of the 1970s with mounting political pressure. Questioning the value of central bank independence, unthinkable for decades, is now the norm. And against this volatile backdrop, digital asset markets are startling for their stability. This is gaining mainstream attention – Bitcoin is openly considered a potential ‘safe-haven’ asset. Sentiment around stocks, bonds, and the US dollar are concentrated – when a countertrend emerges, assets that have played defensive roles are the natural candidates to play the strongest offense. When central banks blink, digital assets awaken.