May 2, 2023
Banking on Trouble
Banking sector concerns once again took center stage this week, with First Republic Bank (FRC) revealing in their earnings update that deposits plunged more than $100bn in Q1.😬
Despite a revenue beat, deposits as of 21st April stood at a lower-than-expected $102.7bn, down from $172bn as of year-end (this despite the $30bn received from the consortium of US banks). Expensive, short-term borrowings also stood at $104bn, raising question marks on the bank's sustainability which, as I write, looks set to be taken into FDIC receivership. FRC shares are trading down over 75% on the week. The bodies from the Fed’s aggressive hike cycle are slowly but indeed piling up.
Bitcoin received a boost from its role as the hedge against fiat system failures. In last week’s Macro Pulse, we highlighted the “bubbling bank stress” with banks tapping the BTFP and discount lending window again and that trend continued this week with the BTFP usage up at $81.3bn from $73.9bn and discount window at $73.8bn from $69.9bn. There are no dramatic increases, but the stresses remain as banks struggle to deal with an asset/liability mismatch made worse with every Fed hike.
FRC troubles and how depositors are treated in a liquidation event will have significant ramifications for other regional banks. How the $30bn deposits from the large banks get treated will be especially interesting and adds another layer of complexity to this scenario 🍿. These issues are not going away whilst Fed rates remain at these levels and ultimately lead to one of two outcomes. Either a profound credit crunch that forces rate cuts, or the Fed balance sheet explodes higher as they’re forced to supply liquidity to prevent a contagious collapse of the banking sector. Both scenarios will be bullish Bitcoin, and it looks a case of when not if. 🚀
Shorter term, however, the liquidity tailwind that has helped to power the crypto move higher in 2023 is fading. The Fed balance sheet contracted this past week again, down $30.5bn as QT re-exerts its dominance, with little off-sets from the other major Central Banks. Liquidity levels still remain relatively high, but the impulse is fading short-term and is something we continue to monitor closely.
One powerful liquidity offset to the Fed QT has been the BoJ’s balance sheet expansion as it buys bonds as part of the Yield Curve Control (YCC) programme. This week saw the new Governor, Kazuo Ueda’s debut policy meeting. Expectations have been growing that the BoJ is ready to tighten policy and move away from YCC. Yet, whilst maintaining the policy status quo on rates and current yield targets (as expected), the bank said it “decided to conduct a broad-perspective review” of its easing measures, with a planned time frame of around 1.5 years to complete the review. The step away from YCC kicked into the long grass, JPY abruptly selling off, 10yr JGB yields down some 10bps.
This is a significant development, not just as it relates to liquidity but also for the US bond market and my bullish duration view.
As the largest foreign holder of US treasuries, a change to domestic policy in Japan which drives domestic yields higher will have significant ramifications for portfolio allocations, which would likely see holdings of foreign assets sold and repatriated to receive higher domestic yields. This would see global bond yields move higher and risk assets sold. This risk has been hanging over the bond market since the BoJ surprised markets in December by widening it’s target range for 10yr JGB’s to +/- 50bps. Risks of an imminent shift away from YCC, therefore, fading, leaving a cleaner path for treasury yields to move lower in line with slowing growth.
Speaking of growth, this week’s GDP numbers confirmed the softening US economy, with Q1 GDP coming in at a tepid 1.1%, weaker than the 2% expected and down from Q4’s 2.6%. Complicating things for the Fed, Core PCE prices for Q1 came in stronger at 4.9%, up from 4.4%, giving a stagflationary feel to the data. Friday’s core PCE for March at 4.6% YoY down from 4.7%, maybe allaying some concerns along with Powell’s favored core PCE services ex housing also softening at 0.24%.
Headline inflation has certainly peaked and continues to move lower; it’s just the pace of that disinflation still remains too slow for the Fed to give the all-clear. Wednesday’s FOMC meeting, then, is hugely important to hear how JPow is balancing the growth/recessionary risks against stubbornly high inflation, all against a backdrop of a brewing banking crisis!
My expectation is that we are “one and done” as JPow hikes a final 25bps and tees up a pause. He will remain hawkish on inflation, ready to act if the data so requires, but with “long and variable lags,” will acknowledge the increased risks to growth and the credit tightening coming from the bank sector as reasons to “wait and see”.
Markets will of course spend the ensuing days debating if he was hawkish/dovish which will induce some price volatility, but stepping back and in line with our bullish thesis here on the Macro Pulse, the Fed have gone from a 75bp hike pace to a pause. Wherever rate cuts come down the line, this is an entirely different macro regime to the one that decimated crypto and all risk assets in 2022. Rates have peaked (10yr yields peaked in October) and will provide a supportive backdrop to our markets.
Pain to the upside
Broadly, the risk backdrop looks supportive. Better earnings out of the tech sector are powering stocks higher. Vix, as a measure of expected equity volatility, now sits on a 15 handle, its lowest levels in over a year. The Move Index, a measure of bond volatility, also continues to drift lower from its Feb/March peak highs. This could well bring back the influential risk parity funds, which make leveraged allocations across assets depending on volatility. The pain remains to the upside for a market still under-positioned risk. Whilst correlations between Bitcoin and equities have declined over the past couple of months, crypto remains a high beta risk asset. It will benefit from a continued move higher in equities.
I understand concerns around recession, but rates and liquidity are such vital drivers in this fiat-based world. The growth slowdown and impending recession will go hand in hand with the bottom for the liquidity cycle and as the liquidity tide rises, all boats will be lifted. The Bitcoin boat, of course, will be lifted highest. As the excellent Noelle Acheson said on our recent Big Picture podcast, Bitcoin has no earnings or credit rating vulnerability and is untethered to the real economy except through the impact of liquidity flows. Lower rates and more liquidity is a powerful concoction for crypto, and the mixologist is ready to get shaking.🍸
Flows and Vol
Flows on Paradigm Friday looked to take advantage of cheap vol with little risk premium embedded in implieds as 30 day vol trades in line with realized. Substantial upside buying with 26-May 32k and 33k Calls a focus, no doubt, with one eye on the potential for the FRC failure. The week was otherwise dominated by vol selling which is interesting given the cacophony of risks building within the banking sector and ahead of FOMC.
The market is yet to fully recover from Wednesday’s mini dump on Mt Gox and US government rumored sales, and we feel a little stuck with dealer long gamma containing price moves. Looking at GVOL GEX, some large long gamma to chew through at 29.25k and 29.5k, but the path through 30k through to 33k looks cleaner with negative gamma potentially propelling a move higher should an FRC failure trigger.
Huge week ahead for markets and Crypto, then with an early focus on the FRC resolution, while ECB and Fed headline the Central Bank decisions, all rounded off with a Friday non-farm payrolls. Whilst caution may prevail into these events, the peak inflation, peak rates, peak Fed narrative that has been a significant driver of Bitcoin outperformance in 2023 remains firmly on track. Another bank bailout alongside confirmation of a Fed pause would be a nice trigger for the next leg crypto higher. 🚀
David Brickell 💜