Connecting the Dots

Episode 6 - New Year Macro Fireworks

The first week of Jan is typically slow in markets and 2023 has proven no different as traders slowly drift back to their desks.

Bitcoin has captured the lethargy as implied and realized volatility continues to grind to new lows with prices confined pretty much to a 16,600-16,900 range for most of the week, having failed to take out 17k resistance. Crypto bro's looking at their tradfi friends with vol envy!

Macro fireworks…

Yet whilst volumes were muted, the macro started with a bang, reinforcing our big picture view.

Namely, that we're in a shifting macro regime as markets price peak inflation, peak growth and peak rates.

Europe led the peak inflation narrative with a string of weaker inflation prints with German inflation falling to 8.6% (10% prior, 9.1% exp) and French CPI at 5.9% (6.2% prior, 6.2% exp).

The Fed minutes from the December meeting contained little new information, maintaining their hawkish line and pushing against rate cut bets. We get the message. The Fed as they near the pause, don't want markets front running them. Or put another way 👇

The BIG news however came from Friday's data release in the form of Non Farm Payrolls and ISM Non Manufacturing.

The headline employment number continued to paint a picture of a healthy labour force, with a consensus beating 223k jobs added in Dec and the unemployment rate falling to 3.5%. This typically would have seen risk and bonds hit as markets price a higher for longer path for the Fed, but the "good news" (remember that peak inflation narrative) was that wage growth slowed substantially with Average Hourly Earnings at 4.6% Vs 5.0% consensus and down from 4.8% the month prior.

Whilst the labour market is probably the biggest factor maintaining Fed hawkishness, the fall in average earnings suggests the labour market isn't as "tight" as feared (looking under the hood, the details were also weaker, with most jobs added being part time, which typically receive lower wages)

Service sector contraction…

The piece of news however that really got markets going was the ISM Services index which came in at 49.6, down from 56.5  and Vs consensus of 55.0. This activity survey suggesting the service sector in the US is now in contraction (50 separates contraction from expansion).

Services are circa 80% of the US economy and has been the area that has remained strong post Covid reopening and in the face of Fed hikes (manufacturing has already been in decline with the global growth slowdown) so this is big news and one that will concern a Fed who has already stated that risks at this point between growth and inflation are more 2 sided.

Yields immediately responded and the spread between 10yr and 3month yields fell to new negative lows of -94.5 basis points. This has a 100% hit rate of forecasting a recession. Consequently markets are now pricing 50bps of CUTS between June and Dec 2023

✅ Peak inflation

✅ Peak growth

✅ Peak rates

An asymmetric play…

Long duration (longer dated bonds) have been a favourite macro trade of ours coming into 2023 given the perfect set up of peak inflation and peak growth. Increasingly this looks an asymmetric trade because any “pivot” from the Fed will see yields lower across the entire curve (accompanied by a curve “steepening” as yields with shorter maturity fall faster) whilst a hawkish Fed that remain “higher for longer” as they look through the rear view mirror will cause a deeper recession and deeper curve inversions driving long end yields lower.

Tying all of this back to crypto. Crypto is the longest duration asset (duration measures the sensitivity of an asset to changes in interest rates) and if peak rates drive a rally in duration, then I expect crypto to start to outperform.

Now, of course markets aren’t so black and white. Crypto is also a high beta risk asset so we could see bonds rally hard, but equities fall in a risk off scenario and that will keep crypto on the back foot. However rates and liquidity are the important drivers of risk and as we’ve laid out before, both are improving into 2023. The liquidity side being helped by a weaker dollar (USD fell circa 1.6% Friday) and weaker oil (oil is down 8% over the last week!) as well as continued decline in the Fed’s Reserve Repo facility as money market funds move cash back into markets.

So the macro is lining up nicely for us Crypto Diamond Hand Degens 💎

Also lining up nicely are the technicals. We wrote in our year end piece that we’d like to see ETH/BTC cross break the down trend and move higher as a bullish signal for the wider crypto complex and wow, the break came much sooner than we anticipated (ETH’s volatility is higher than BTC and so is a higher beta, which typically means it sells off more in a bear market, rallies more in a bull market. Hence, ETH/BTC trading higher has typically been a sign of a more bullish undertone) Indeed the altcoin space has been pumping to start 2023 🎉

ETH/BTC breaking higher…we love to see it

Bad headlines everywhere…

Elsewhere however, crypto continues to be plagued by bad news stories and the fall out from FTX. In particular, focus is on DCG/Gemini as Winklevoss publicly accuses DCG’s Barry Silbert of stalling on paying back money to Genesis and allowing Gemini Earn users to reclaim funds. An 8th Jan deadline has been set to resolve the issue 👀 Genesis announcing large cuts to its workforce is doing little to ease fears of an impending bankruptcy.

Meanwhile, Silvergate Bank shares got smashed as they announced depositors have withdrawn $8bn of deposits, forcing Silvergate to sell assets to meet the liquidity needs and book a $718mio loss on the firesale of those assets. Coinbase also received a $100mio fine for breaching AML requirements. Urggh, it’s still ugly out there!

A bottoming out process…

One piece of good news bucking the trend; Blackrock announced they are adding Bitcoin to their $15bn flagship Global Allocation Fund. Institutional adoption is not going away!

We keep a close eye then, on these developments and it feels like we need a resolution of the DCG drama if digital assets are going to launch a sustained recovery. Further bankruptcies will only feed a continued negative low dynamic, although much of the leverage has now been taken out of the system so it still feels like we’re in the bottoming out process.

The macro environment also remains highly uncertain and volatile, but there we take comfort that our view is unfolding as we’ve outlined previously.

However the mood music has changed and crypto looks like it’s ready to get its groove on 💃

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DISCLAIMER: The content in this newsletter is not financial advice. This newsletter is strictly educational and is not investment advice or a recommendation to buy or sell any assets or to make any financial decisions. Crypto markets are volatile, please be careful and do your own research.