April 3, 2023
A quieter week for markets as banking sector stress simmered and month/quarter-end considerations dominated. The positive momentum continued, however, with tech stocks leading a 1.5% rally on Friday as the Nasdaq capped its best quarterly performance since Q2 2020.
US PCE inflation data was one of the few data highlights and came in softer than expectations, adding a tailwind for risk.
The Fed’s preferred core PCE measure came in at 0.3% on the month (down from 0.5%) and 4.6% on the year (Vs 4.7% exp) the smallest increase since October 2021. In addition, inflation excluding housing and energy, which JPow has identified as important to monitor, also moderated to 0.3% in Feb and at 4.6% YoY was the smallest increase since last July.
Whilst the Fed will want to see further progress on the pace of disinflation, the data will calm fears that took hold in February of a “re-acceleration.” Indeed, February’s data increasingly looks like a blip, and the peak inflation narrative that formed part of our positive view in Jan looks to be intact.
This, of course, pre-dates the recent tightening in financial conditions and likely retrenchment of bank lending amidst the banking crisis, as well as lagged impacts of previous tightening, which increasingly will start to bite into Q2 and beyond. Peak inflation ✅.
The Fed Pause
Markets are priced 50/50 for a May 25bp hike and still pricing circa 60bps of cuts between June and year-end (down from 100bps just a week ago.)
Interesting too, a speech from the Fed’s Waller on Friday had a dovish undertone, suggesting that inflation could fall quite quickly, without unemployment needing to rise materially. Waller led the hawkish camp in late 2021 so it is perhaps significant that he sounds a touch more sanguine. Given the increased risks emanating from the banking sector, there’s plenty to support a May pause.
Either way, within the macro framework, the “peak rates” narrative also receives a big ✅.
and a market still under-positioned risk needs to adjust to a vastly different macro backdrop relative to 2022. On Friday, the best economist in the world, 2yr US yields, posted its largest monthly drop since 2008. Message received .
Riding the liquidity wave🏄
Liquidity continues to flow. The Fed's balance sheet contracted circa 28bn but expanded by 366bn in March. The ECB’s balance sheet has expanded over the last two weeks. China pumped an additional CNY 850bn ($125bn) in the past week as they managed quarter-end liquidity.
This tidal wave of liquidity will continue to propel risk assets and crypto—the below chart of Nasdaq and BTC Vs. Trading View’s measure of global net liquidity demonstrates visually how high beta risk loves to ride the liquidity wave…
The dollar ended the month down over 2% as the Fed’s massive liquidity injections plus rates re-price weighed. A weaker dollar is another part of the macro-framework that supports crypto 💪.
As is customary when the dollar starts to sell off, Fintwit and the broad financial media rush out their “dollar demise” pieces 🙄.
Fanning the flames was news this week: Brazil and China have reached a deal to trade bilaterally using their own currencies, replacing the dollar. China also settled its first LNG trade in Yuan last week. The BRICS nations (Brazil, Russia, India, China, South Africa) are reportedly discussing a new gold-backed unified currency for the bloc.
“The transition to settlements in national currencies is the first step. The next one is to provide the circulation of digital or any other form of a fundamentally new currency in the nearest future,” the deputy chairman of the Russian State Duma was quoted as saying.
Whilst there is a clear desire to transition away from dependence on the US dollar (one that I would welcome,) any process of “De-dollarisation” will take decades to play out. The below chart shows the major currencies’ share of global transactions since 1989 (H/T Brent Donnelly of Spectra Markets).
As is clear, the challenge to replace the dollar’s dominance is a sizable one, and having read “dollar demise” pieces frequently for the past 20 years, there’s little sign of a material rotation away from the dollar yet.
Indeed, with over $17trn in dollar debt issued outside of the US, any significant rotation for global trade away from the dollar would first result in dollar strength as the velocity and availability of dollars fall, yet the dollar liability remains. Over the past couple of weeks, there's a reason why the US Fed had to open swap lines to supply dollars and not another central bank!
Additionally, FX is a relative game and in the fiat world, there is no viable alternative. China doesn’t have a freely floating currency and doesn’t even have free, fully open capital markets. In Europe, the structure of the single currency without a fiscal union provides constant instability and talk of a EUR break-up. Right now, the dollar remains the cleanest shirt in the fiat laundry.
That said, whilst I’m not outright bearish the dollar, I am outright bearish fiat currency which, in an over-leveraged, indebted world with slowing population growth will continue to need to debase and will continually be dependent on respective central bank liquidity. Events witnessed in March quell any doubts surrounding that thesis.
If the BRIC nations seek a new digital currency that negates dependence on a single, centralized authority, Bitcoin looks a good alternative 👋.
Whilst then I put little value on the current hysteria around the “dollar demise,” it continues to support the powerful “digital gold” narrative for BTC and the conversation highlights a fiat system that is failing and in search of alternatives which will continue to drive more flows into Bitcoin.
Speaking of flows, this past week at Paradigm has seen some mammoth flows as funds piled in to topside trades 🔥🔥.
Notably, the demand to own the upside began on Tuesday as spot had sold off post the Binance CFTC news (interesting how short-lived the spot price impact from negative headlines out of the US is. A year ago, these headlines would have had a much deeper negative impact, but the market sensitivity to the US aggression towards crypto is waning and less of a headwind with the banking failures and changing macro a much bigger focus and positive tailwind for Bitcoin)
Lower spot and implied vol levels saw demand to own 28th April 34k and 35k BTC calls. The buying picked up on Wednesday with Call spread buying in the May dates and Thursday saw the 5th largest volume day ever on Paradigm, with huge purchases of 3,000x BTC 29-Mar-24 50k/65k Call Spreads and 1500x BTC of 30-Jun-23 29k/35k and 35k/40k Call spreads stand out trades.
Fund flows continue to use lower spot/vol to BTFD and position for a continued move to the topside ✍️.
Also notable on Thursday was a 10,000x ETH 7th April / 28th April 2k Call calendar which was purchased. Are markets finally starting to position for trades around the Shanghai upgrade? Certainly relative implied vol for ETH looks “cheap” and presents opportunities into April. The negative skew towards puts suggests a market still cautious for the downside risks emanating from the “unlock.”
Overall, despite a phenomenal Q1 which saw BTC outperform all assets with a 70% return, the macro backdrop remains supportive for crypto as we head into Q2. The banking issues, whilst becalmed, are unresolved with front end rates simply too high. As a result, deposit outflows will continue, and the supply of Fed liquidity will be required to avoid forced selling of underwater assets on bank balance sheets which would drive another run of insolvencies.
Additionally, on top of the lagged effects from the aggressive tightening cycle of the past year feeding through, bank lending will likely fall sharply and weigh heavily on both growth and inflation.
I suspect rates will continue the path lower. Markets broadly remain under-positioned risk and have been caught trading the 2022 playbook (expect to hear of hedge fund failures in the coming weeks 👀.) Crypto has been battle-tested over the past year and looks to be coming back stronger than ever. This is a new paradigm. LFG 🚀.
David Brickell 💜