February 7, 2023
Pause for Thought
Central banks took center stage in the macro world this week and continued supporting the “peak rates” theme.
The Fed hiked 25bps as expected, yet markets anticipated that JPow would push back on market pricing for rate cuts and the “unwarranted easing in financial conditions.”
In the event, he took a far more sanguine view, characterizing financial conditions in the context of the past year, noting they have tightened “significantly” over that period. He also echoed Brainard’s comments that there’s no sign of a 70’s style wage spiral, despite the apparent tightness in the labor market.
The lack of pushback to markets greenlighted the rally, and US yields fell across the curve, with 2yr yields - the “best economist” in town 🤓 - dropping circa 20bps to lows of 2.04%
Meanwhile, the Bank of England hiked 50bps but hinted at a pause, dropping guidance that it will “respond forcefully if needed” and Governor Bailey said, “if risks continue to overshoot in wages and services, then we will have to respond, but we can reevaluate.” 2yr Gilt yields similarly dropping 20bps.
Perhaps the biggest dovish “pivot” coming from the ECB which, whilst hiking 50bps and nailing on another 50bps for March, hinted also at a pause as “future decisions will be data dependent.”
NFP and ISM spoil the party…
Just as the pivot party 🎉 was starting, however, Friday delivered two big data releases in the form of Non Farm Payrolls and Services ISM, and they came in super hot 🔥.
Headline payrolls came in a blowout 517k Vs. 185k exp and ISM services bounced from a contractionary 49.2 to an expansive 55.2. Whilst there are typically adjustment issues in the Jan NFP data, there’s no getting away from this being a strong number and the labor market remains solid (even if lagging) - the unemployment rate is now at the lowest in over 50yrs at 3.4% 🤯.
Time will also tell if the bounce back in services sustains or we continue on the data downtrend we saw into the latter part of Dec. Monetary policy typically acts with a 9-12 month lag and 12 months ago, we were at 0 rates still doing QE. My expectation is that we will see a continued slowing to reinforce a Fed pause and eventual pivot.
Also, important in the data was Average Hourly Earnings. This came in at 4.4%, down from 4.8% (Tuesday’s Employment Cost Index also down at 1% Vs. 1.2% prior) and reinforced the recent view at the Fed that there’s no sign of a 70’s style wage-price inflation spiral.
Nonetheless, markets quickly reversed the post-Fed moves, with the dollar bouncing sharply along with US yields. Our economist friend, 2yr yields, retracing and now sat uncomfortably in the 4.25-4.30% range 😬.
The crypto rally consequently hit pause with BTC topping out at a prior resistance zone around $24,250, ETH briefly tagging the $1,700 level.
Where does this leave us?
In terms of the macro drum 🥁 I’ve been beating since early Dec, there continues to be a paradigm shift (no pun intended) in the underlying dynamic as we transition from a Fed driving the global hiking cycle, to now the approaching pause.
Inflation continues to also roll over. The peak rates, and peak inflation narrative remains strong. Rates of change matter too. Even if the data stays stronger, inflation stickier, to allow a “higher for longer” Fed, 2023 continues to look a lot different to 2022 and more supportive for high beta risk and crypto 💪.
Short term, we’ll keep a close eye on our friend, the 2yr yield as well as the dollar. Should both gain momentum higher, then I suspect BTC and ETH will consolidate and vol drift lower into the important CPI release on 14th Feb ❤️.
Rates and dollar then are a potential challenge short term to our constructive moonboy view 🚀
Other important elements of the macro framework look supportive however. Liquidity is set to remain easier as the US debt ceiling will see the Treasury General Account (TGA) at the Fed get drawn down and provide a powerful off-set to quantitative tightening.
✍️ NB: The TGA is effectively the Treasury’s checking account at the Fed. When they build it up, they do so by issuing bonds, taking liquidity out of the market. With the debt ceiling reducing the ability to borrow, they spend the cash, injecting liquidity back into markets.
The PBOC and BoJ balance sheet expansion is also outpacing the contraction by the Fed and ECB. Net, the G4 central bank balance sheets are expanding again adding positive liquidity momentum to markets.
Positioning and flows…
Then there’s positioning and flows. The market into 2023 continues to be under positioned risk as we’ve seen from various surveys. With BTC up circa 40% so far in 2023, many funds are left chasing performance. Money is also flowing into crypto funds. The latest CoinShares “Digital Asset Fund Flows Report” shows the highest weekly inflows since July 2022, with $117mil flowing into crypto funds in the last week of Jan. Crypto AUM is now at $28bn, up 43% from the November 2022 lows.
This money has to be put to work and if managers started the year cautiously, under positioned risk, there’s likely to be solid demand on pull backs. This is still a BTFD market 💥.
Flows at Paradigm on Friday continued to be focused on buying the topside and also rolling up strikes. Friday’s data then doing little to dissuade the positive sentiment.
Time for alt season?
Also in the world of crypto, it is interesting to see ETHBTC reverse off of support and looking to break higher.
We spoke on the most recent The Big Picture podcast about how flows in 2023 have been focused in BTC, with BTC Open Interest (OI) flipping the ETH OI (which built largely on merge based trades last year) - I speculate that this is largely due to the rally being driven by the underlying change in the macro dynamic as markets start to position for a Fed pause and so is a pure “monetary” based play. Even boomer gold has been flying!
With ETH “skew” still trading better for puts over calls, is now the time for ETH topside trades to dominate? If in the short term, rates markets consolidate and are less of a driver, it may be the time for alt season rotation led by ETH outperformance over BTC 🤔.
Important week ahead then in terms of how markets digest the strong data in the context of central banks still set to hit the pause button. Risk may well take a “goldilocks” view as inflation rolling over allows the pause, without the dreaded recession. Falling inflation driven by continued easing of supply chains, alongside still reasonable growth would be a “right tail” bullish event many are not ready for.
Some caution here then at The Macro Pulse as we watch to see how the dollar and rates perform. However, liquidity and flows remain supportive with a market still under-positioned for this shift in the macro dynamic. Consolidation in the macro factor inputs could spark the rotation for some alt season sizzle 🔥 2023 hits different in crypto 👊.