Connecting the Dots
Episode 2 - The Macro Sands are Shifting
Key Points (and quick read for beginners).
It’s been a very interesting week in macroeconomics.
Why? Well press in the US suggest Fed interest rate hikes will slow down and market reaction suggests the same. This has caused the US dollar to weaken and cryptocurrencies to rise.
Crypto remains dependant on liquidity, so we watch closely for any movement on the US liquidity facilities, namely the treasury buyback programme.
With increased talk of interest rate hikes ending and possible central bank liquidity injections, the green shoots of a crypto bull market could be appearing.
It’s been an interesting week in macroeconomics and a potentially significant reversal to macro trends which have obliterated risk sentiment in 2022.
The headlines have been grabbed by the Fed mouthpiece, Nick Timiraos, with his Wall Street Journal article that suggested whilst the Fed is set to raise interest rates by 75bps next week, there will be a discussion on how to slow the pace of hikes and importantly, how to communicate that to markets. Remember we said last week the Fed is key, well this is significant.
Beginning of the end
Whilst not a pivot, or even a pause, markets respond to the direction of travel and rates of change and it's clear we're nearing the end of this US hike cycle. The data is starting to slow sharply (this week, US Manufacturing and Service PMI's all posted in contractionary territory and house price data plunging the most since 2009) and several Fed members are finally starting to consider the lagged impact of policy, voicing concerns about the risks of over hiking amidst what has been the fastest and sharpest tightening of financial conditions in recorded history.
Yield Curve Control? (Warning – it gets a bit technical from here!)
Perhaps the most important development however has been the hints from US Treasury Secretary Janet Yellen around treasury buybacks. Concerns are growing around Treasury market liquidity and stability. With the Bank of Japan (BoJ) and Bank of England (BoE) already being forced to intervene to support their domestic bond markets, Yellen has been consulting with primary dealers (the banks approved to buy Treasuries directly from the Government) on the potential for buybacks to provide stability.
This would be funded by issuing shorter dated T-bills and is effectively a form of yield curve control. As we've seen with the BoJ and BoE, yield curve control and artificially suppressing yields in the longer end of the curve, typically leads to a weaker currency. Yellen’s comments come at a convenient time…the US dollar has been trading at multi year highs, thus suffocating the global economy and crippling domestic currencies who's Central Banks are burning through reserves trying to support them. So, what have we seen this week, the dollar fall sharply from its highs.
It's all about liquidity...
With US yields reversing lower and USD weaker, the market is feeling relief from easier financial conditions. But the BIG event for markets, which in a post 2008 world are merely a function of Fed rates and liquidity, is the potential for the Treasury buyback programme to unlock the circa $2 trillion parked in the Fed's overnight reverse repo facility (RRP).
This facility is designed to keep a floor on short term rates by offering an alternative place for Money Market Funds and banks to deposit cash, rather than swamp demand for a limited number of T-bills and drive money market yields lower, counter to monetary policy goals. By issuing more T-bills, this money will leave the Fed's RRP and fund the Treasury borrowing, meanwhile with the treasury buying back longer dated bonds, investors are forced out along the risk curve and the impacts start to look and feel very much like those under QE.
Crypto prices breaking higher 🚀
Short term, crypto remains a high beta risk asset dependent on liquidity. Like growth stocks, crypto is also a long duration asset which benefits in a low growth, low yield environment.
The potential for a sustained reversal lower in yields alongside the firehose of liquidity returning to the markets could provide the rising tide that lifts all boats...and crypto is no ordinary boat, it's a Super Yacht and the anchor is drawing in!