January 31, 2023
The Calm Before the Macro Storm
A huge week ahead for macro and markets. Headlined by the Fed, but with the BoE, ECB, US ISM, Non-Farm Payrolls, EU inflation, and GDP, this is a macro geeks Burning Man🤓
Over a month ago, on our The Big Picture video series, we boldly claimed, “This is the bottom!” as I outlined my macro framework as a lens through which to view crypto.
After a bruising 2022, with the sharpest Fed tightening cycle in recorded history and inflation climbing toward double digits, the macro backdrop into 2023 looked vastly different as we hit peak inflation, peak rates, peak Fed.
An underlying shift in the macro dynamic was underway, best indicated by the “dollar wrecking ball,” which convincingly broke below the 2022 uptrend in early November and has been in decline ever since.
FX, perhaps better than any other asset class, can sniff out regime change, and given how the dollar had strangled virtually every asset class in 2022, the breakdown was an important signpost to this changing regime and ultimately, marking a potential low for high beta risk assets.
Over the past week, the broad dollar has drifted sideways along a BIG support zone and will be a key indicator to watch through the Fed to determine short term, whether the risk rally continues or corrects.
Bank of Canada leading the pause…
In terms of monitoring the “peak inflation” narrative, this past week brought US PCE inflation data. The headline number confirmed the continued slowing in inflation, at 5%, down from 5.5% the month prior. More importantly, the Fed’s preferred measure, core PCE, came in below expectations at 4.4% and significantly below the 4.8% forecast the Fed penned just in Dec. The Fed funds rate is now above core PCE for the first time since Feb 2020. The pace of disinflation, a positive surprise to the Fed, which will secure a slower 25bp pace of tightening this week.
Also providing the Fed with comfort that inflation expectations remain anchored, the Uni Mich survey (which Powell has referenced previously) showed consumer expectation for inflation falling to 3.9% for the next year (down from 4.4% in Dec) and five year expectations dipping to 2.9% from 3%.
All in, with the Fed increasingly highlighting risks of additional tightening being more “two way” as growth dynamics grow more concerning, there’s little in the data to dissuade a March “pause”.
Indeed, the Fed’s neighbors to the North, the Bank of Canada, on Wednesday announced its own “hike and pause,” completing a final 25bp hike to 4.5% amidst signs that the economy is cooling. Like the Fed, the unemployment rate is near record lows with inflation still at 6.3% and not expected to return to the 2% target until 2024. As Central Banks start to acknowledge the lagged impact of monetary policy and move into “wait and see” mode, the “peak rates” call looks solid✅
The best economist out there…
One small area of concern over the past week has been the pullback in yields, with the US 2yr back above the 4.14% support level, which we had finally broken post the weak PPI and retail sales data a couple of weeks ago.
Powell on Wednesday will attempt to sound hawkish, warning against “unwarranted easing in financial conditions” as he attempts to reign in markets from front running the Fed pause/pivot.
But the “voice” to listen to is that of the bond market. This is the best economist out there and the best gauge on where Fed policy is headed. I want to see 2yr yields continue to press lower to sustain the positive momentum in crypto. Currently at 4.20%, a sustained move above 4.25% will give pause for thought and I’ll be paying close attention to this post Fed. We’re in an important zone…
Much like the pace of the risk sell-off in 2022, markets appear caught out, under-positioned for the risk rally we’re witnessing to the start of 2023. An investor fund survey from BofA showing US equity underweights at their biggest underweight since 2005 is perhaps a good proxy for broader risk positioning.
Indeed, so far, much of the rally appears driven by short covering and momentum funds chasing higher as we cross key tech trigger levels. Not for nothing, the Nasdaq on Friday climbed above its 200-day moving average for the first time in a year.
In crypto, open interest on exchanges is climbing but remains below pre-FTX levels and a long way below any kind of levels one would associate with a local top. The consolidation in price over the past week looks constructive after the sizable moves seen to start the year. There’s no signs of FOMO to raise concerns of a liquidation-led reversal and limited appetite currently to aggressively sell into the rally.
Flows before bro’s🤜🤛
Flows meanwhile at Paradigm continue to be dominated by upside buying which in BTC has driven the “skew” to turn positive for calls over puts across maturities. Some trimming of positions and selling of the skew ahead of the Fed, but the pattern of flows maintains a clear bias for the topside. Crypto funds positioning for the bullish breakout🚀
As we head into a huge Fed-led week for Macro, it feels this could be a pivotal week for crypto and broader risk.
I’ve written frequently that this move to start 2023 has a fundamental macro basis and is not simply a “bear market rally” to fade.
Markets have been caught trading the 2022 playbook, and this week could prove a defining “towel-throwing” moment where those assumptions get updated and form the base for the next leg higher for crypto. Dollar, rates, risk, liquidity, and flows are certainly pointing that way but are at critical inflection points.
Will JPow be able to break the party up? It feels like the party bus has already left the station🕺🏻
David Brickell 💜