May 16, 2023
Calm Before the Vol Storm
A difficult week for crypto majors, with Bitcoin breaking below the low end of this broad 27k/30k range we’ve been stuck in throughout May and diverging from an otherwise stable risk backdrop, with the Nasdaq pushing to new yearly highs.
This week’s data highlight came in the form of US CPI. Although with the Fed leaning on an expected credit tightening to halt the hikes, the early focus was on the Senior Loan Officer Opinion Survey (SLOOS) to get a look as to how the banking sector stress in March affected Q1 credit. Whilst only catching the tail end of the quarter, credit conditions were indeed shown to have tightened, with banks said to have “tightened standards across all loan categories,” and perhaps more interesting, loan demand fell to its lowest levels since 2009. The credit crunch is already starting to bite 😬.
US CPI came in at a weaker 4.9% Vs. 5% exp and, having peaked at 9.1% last year, is the lowest print in 2 years. Core a more elevated 5.5%, down from 5.6%, but the “super core” (core less rent and shelter - JPow’s preferred measure) came in a cooler 5.1% YoY, 0.1% MoM as the lagging shelter/rent inflation finally starts to turn lower. PPI reinforcing the softer inflation narrative, with the headline coming in at 2.3%, down from 2.7% (a year ago, this was printing 11% 🤯).
Meanwhile, China saw its weakest CPI print since Feb 2021, coming in at just 0.1% YoY, down from 0.7%, with PPI coming in at a deflationary -3.6%. Imports also fell 7.9% YoY in April. No signs of the feared inflationary impulse from China’s reopening. China's PPI, as the world’s largest goods exporter, is also typically a lead on US CPI and, like many other leading indicators, suggests US CPI should start to accelerate lower into the second half of the year👇.
Sticking with China and new loans data rose at a slower pace in April of CNY 719bn, down from 3.89trn in March, whilst Total Social Financing was at CNY 1.22trn, down from 5.38trn and less than the 1.22trn expected. This slower rate of credit suggests more caution from banks after front-loaded easing in Q1 and bodes poorly both for Chinese and world growth.
As it relates to crypto, the Chinese Credit impulse typically has a strong positive correlation with BTC, and this tentative slowing adds to another negative “liquidity” story on top of the looming debt ceiling raise in the US, which will likely see a flood of treasury bill issuance draining even more liquidity from markets. Of course, with Chinese growth stuttering post re-opening, the PBOC won’t hesitate to cut rates and flood the system with more credit. For now, however, the liquidity environment has become more challenging and is turning from a tailwind into a headwind.
A slowing China is also generally negative for the emerging market world and global growth. Typically, slowing global growth leads to US dollar outperformance, as in a dollar-based world, less international trade means fewer dollars circulating, which means a supply/demand imbalance given the size of outstanding dollar debt in the world. This is why the incessant “dollar demise” hit pieces are, at best, premature.
Signs of the lagged impact of tightening by global central banks started to feed through and slow global economies. Perhaps this frustrated the efforts of dollar shorts to break the lows this week, instead bouncing 1.5%. This dollar bounce is another negative factor weighing on BTC this week.
For now, a bounce within a downtrend, but USDCNH climbing toward 7.00 looks a little concerning. I’ve written before China’s PBOC will “smooth” currency volatility by selling USDCNH to keep a lid on things, then repurchasing the USD against other currencies to maintain stable FX reserve ratios. This would be negative for Bitcoin.
A slow-moving car crash…
Banking stress also continues to bubble under the surface. Unadjusted deposit data continues to show outflows which looked to have continued this week given Money Market Funds saw $18.3bn of inflows (that’s circa $120bn of inflows in the past three weeks, a large part of which would have been deposits leaving banks in search of higher yield.) Meanwhile, the Fed’s Bank Term Funding Program usage rose another $8bn to a new high at $83.1bn. Regional bank equities also continued the trend lower after last Friday’s sharp dead-cat bounce, with the KRE regional banks index down 5% weekly. This is a slow-moving car crash and looks like a case of when, not if, we get another US bank failure which ultimately supports BTC as the hedge against a crumbling traditional fiat system. We remain vigilant 👀.
Ultimately, the banking stress, as demonstrated in the SLOOS, will drive a significant tightening of credit and subsequently weigh on growth and help bring down inflation. US yields continue to chop in a range, but I continue to be bullish “duration” on slowing growth, expecting longer-term yields to fall. 10yr yields, currently at 3.47%, need to close and hold below 3.30% to begin moving to sub 3%. Long-duration performing will be positive BTC as the longest-duration asset. Indeed the other high beta long duration proxy, the Nasdaq, is performing, making new year highs this past week. Bitcoin’s divergence is then frustrating, although some idiosyncratic crypto factors are weighing👇.
Most notably, Binance FUD was the focus this past week when they were forced to halt BTC withdrawals twice in the space of 24hrs temporarily. The reason was due to congestion on the BTC network due to an explosion in BRC-20 Ordinals activity, which has driven up network gas fees which the Binance transaction fee estimator failed to anticipate. Binance resolved the issue by replacing the pending transactions with a higher fee so they could get picked up by mining pools. They are also working on enabling BTC lightning network withdrawals to help in these situations going forward, which is a positive development. Nonetheless, headlines that the world’s largest crypto exchange was halting withdrawals weighed heavily on sentiment for a market hypersensitive to centralized exchange risk.
Feeding the market nervosity, (false) speculation in the week that the US government was selling down a portion of its Silk Road holdings saw BTC sharply reverse its post-CPI gains, falling from around 28.3k and taking out the 27k supports, a move exacerbated by continued thin liquidity. The technical breakdown encouraged some momentum selling and, with a lack of short-term conviction, weighed heavy, briefly touching a 25 handle, with lows circa 25,900.
Vols also popped higher with the spot sell-off, yet remain suppressed, and at Paradigm, we saw demand to buy outright options and a good mix of calls and puts, with 19th May 25.5k and 25k downside targets, 30k strikes on the topside. Similarly, ETH saw some large buyers of 28 July 2300 and 2400 calls, buyers of 1900 Puts.
Still, no significant change to the pattern of flows then, although BTC put/call skew is now positive (puts>calls) out to 90 days (ETH likewise), suggesting a market now skewed more bearishly. However, there remains investor apathy and a lack of conviction to add meaningful positions, which, as discussed on this week’s Big Picture podcast, allows the more mechanical, systematic vol selling strategies to continue to weigh heavy on volatility🩸.
Competing forces then, with fading liquidity and a dollar bounce creating headwinds, US yields failing to break lower... for now. Still, we’re in consolidation mode and looking for 25k in BTC to hold. The medium-term path remains higher as the US financial system stumbles and the Fed pauses and pivots amidst a deepening growth slowdown. The US debt ceiling is muddying the waters and is an unwelcome distraction for a market lacking conviction. Low vols make positioning for the topside via options an attractive play here to avoid the chop-in spot. It certainly feels like this is the calm before the vol storm.
David Brickell 💜