MacroVoices #367 Luke Gromen: USD Update in the Wake of SVB Collapse
Luke Gromen discusses the Silicon Valley Bank collapse as a consequence of Fed hiking cycles that put banks in impossible positions regarding duration risk. He argues this marks the end of the Fed's tightening campaign and predicts a return to high inflation, benefiting gold, Bitcoin, and commodities while being bearish for long-term bonds.
Summary
In this episode recorded after Silicon Valley Bank's collapse, Luke Gromen argues that the bank failure was directly caused by the Fed's aggressive hiking cycle creating an impossible situation for banks. Banks were forced to compete with high-yielding treasury markets while holding long-duration assets that lost value as rates rose. Gromen contends this represents a broader systemic issue where the US government is crowding out its own banking system, similar to what occurred in 2019. He believes the Fed is now faced with a binary choice: continue hiking and risk more banking system stress, or halt tightening and let inflation be the release valve. Gromen predicts the Fed will choose the latter, leading to a resumption of the 'Argentina with US characteristics' playbook - sustained high inflation benefiting hard assets like gold, Bitcoin, and commodities. He discusses how recent geopolitical shifts, including countries settling oil transactions in non-dollar currencies and central banks divesting treasury holdings, are contributing to fundamental mismatches in treasury supply and demand. Gromen sees parallels to World War II, when war drove inflation and bond yields higher despite Fed intervention. He maintains his view that the post-1971 dollar reserve system needs restructuring and argues that recent banking stress signals the Fed is losing control of treasury markets, with the treasury volatility index approaching dangerous levels that historically indicate Fed loss of control.
Key Insights
- Gromen argues the SVB collapse resulted from Fed policy that incentivized banks to buy treasuries through favorable regulations while creating duration risk through rapid rate hikes
- He contends that everyone had the same implicit bet that 'inflation's never coming back' which created systemic vulnerability when inflation returned
- Gromen believes the Fed faces a binary choice between protecting the banking system or fighting inflation, and will choose to protect banks by halting rate hikes
- He predicts a return to the 'Argentina with US characteristics' playbook with sustained high inflation as the release valve for unsustainable debt levels
- Gromen argues the US needed inflation of 10-20% annually for 4-5 years starting in 2021 to reduce debt-to-GDP to sustainable levels, but the Fed panicked and reversed course
- He claims the treasury volatility index at 140 indicates the Fed is close to losing control of the treasury market, with 150 being the critical threshold
- Gromen sees the current situation as the US government crowding out its own banking system, similar to emerging market playbooks of regulating banks into buying government debt
- He argues that war is inherently inflationary and would be catastrophic for bond holders, contrary to conventional wisdom about bonds as safe havens during conflicts
- Gromen maintains his prediction that the post-1971 dollar reserve system will be restructured because it forces the US to offshore its industrial base, weakening defense capabilities
- He observes that recent shifts toward non-dollar oil settlements paradoxically strengthen the dollar short-term by reducing yuan demand while maintaining dollar debt obligations globally
- Gromen advocates a barbell portfolio approach with cash/short-term treasuries balanced against inflation hedges like gold, Bitcoin, and commodities given unprecedented systemic risks
- He suggests the traditional 60-40 stock-bond portfolio should evolve to 60-30-10, toggling between growth/value equities while maintaining smaller allocations to bonds and hard assets
Topics
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