February 28, 2023
Watching and Waiting
US PCE data on Friday rounded off a month of stronger data that continued to reinforce the rapid rates repricing since January. Core PCE Price Index (the Fed’s preferred inflation gauge) came in at 4.7% YoY Vs. a 4.3% consensus and worryingly, a tick higher from December’s 4.6%. Personal spending also came in hot at 1.8% MoM in Jan, up from -0.1% in Dec
The US data remains stubbornly strong and after trending lower since last fall, is showing signs of re-acceleration which will keep the Fed actively engaged, taking the terminal rate higher.
Indeed markets are now pricing a peak rate of 5.4% from just below 5% only a few weeks ago. This implies two more 25bp hikes fully priced, with a high probability of a third 25bp hike.
I came into 2023 with a bullish outlook for risk and crypto based on a shifting macro dynamic as we adjusted to peak inflation, peak rates, and peak Fed world. Clearly, with the recent data flow, that dynamic is being called into question. So where do we stand now?👇
Rates of change matter..
The rates move is a big concern here. Remember the core macro framework:
The 2yr US yields at 4.82% are challenging the Nov highs of 4.88% as market prices that higher terminal rate (and price out subsequent rate cuts into 2024.) When the Fed is hiking, crypto and high beta risk assets typically come under pressure, as we’ve seen over the past couple of weeks.
However, rates of change matter. 2022 witnessed the sharpest Fed hiking cycle in recorded history, with successive 75bp hikes, which markets had to adjust to rapidly. Whilst I was in the camp of expecting a pause post the March hike (and a terminal rate of 5%) we’re now debating between another couple of successive 25bps hikes into May and June.
Fed speak, whilst hawkish, also continues to support this new 25bp pace of hikes (despite market pricing a 30% chance of 50bps in March) - this is much easier to digest and in my view, will limit the downside for risk.
Should inflation re-accelerate and force a subsequent re-acceleration in the pace of Fed hikes and a substantially higher terminal rate, then all bets are off, and risk will endure a much deeper correction.
It feels far too early, however for markets to be pricing such an outcome. In addition, January data has been heavily impacted by “seasonal adjustments,” which typically carry large room for error. Complicating those adjustments has been unseasonably warm weather in Jan. Data over the coming weeks then, will take on increasing significance with an obvious focus on March 14th CPI release.
Other indicators, however, fail to corroborate this re-accelerating growth and inflation narrative. Indeed, broad commodities have traded heavy in Feb, fully reversing any inflationary impulse seen in Jan. 👇
10yr and 30yr US yields also remain 30-40bps below the highs seen in late October, despite climbing throughout Feb (having rejected a break below the 200 DMA in Jan.) These longer-duration yields are the growth proxies and continue to signal that peak growth was seen late October.
Both are approaching a confluence of resistance levels which are worth watching, in particular for crypto which remains the longest-duration asset. A break higher in these long-end yields would point to a deeper correction for crypto.
Also interesting is to watch 10yr real rates (nominal rates adjusted for 10yr inflation expectations), which indicate how easy financial conditions are. Real rates bottomed in Nov 2021, coinciding with the BTC top and topped out in late October 2022. The move in real rates has been less than nominal rates as inflation expectations have been increasing in tandem (which is partly why stocks and crypto, whilst correcting, haven't suffered a deeper correction) and have re-traced the YTD moves. Once again, we topped out on Friday at important resistance levels which crypto bulls will want to see hold if we’re to make further topside progress.
The dollar has also fully re-traced the Jan sell-off. As the world’s reserve currency and with over 17trn of dollar debt issued outside of the US, the dollar is a key macro input and contributor to financial conditions. The huge rally in 2022 strangled financial assets but started to break down late Oct/early Nov.
We remain well below last year's highs and again bounced off some critical resistance levels which we need to watch closely here.
Liquidity continues to be a huge off-set to the tightening in rates, predominantly coming from the East. China continues to pump cash to maintain adequate liquidity in the banking system and to spark economic growth post covid-zero.
The Bank of Japan also continues to print under the yield curve control policy to keep 10yr yields at the 0.5% target.
Interestingly, new incoming Governor Kazuo Ueda, who is seen as more hawkish than his predecessor, reiterated a commitment to maintain Japan’s ultra-loose monetary policy in his first address to Japan’s Diet on Friday. Ueda spoke of the risks of tightening monetary policy when underlying demand remained weak and suggested January’s 41 year high core inflation print of 4.2% was probably the “peak.”
Looking at the recent bond sell-off, it also coincided with the nomination of Ueda and JGB’s coming under renewed selling pressure. Ueda saying, “I believe it is appropriate to continue easing measures while being creative in line with the situation” on Friday may well restore some calm and stability to bond markets this week.
Keeping with the East, last weeks Fintwit chatter that Hong Kong was set to make the retail purchase and sale of crypto legal, was officially endorsed by Hong Kong’s Securities and Futures Commision (SFC,) who released a statement to announce a consultation on the proposed requirements for operators of virtual asset trading platforms. This will inform a new licensing regime to come into effect the 1st of June.
With Hong Kong viewed as a trial ground for the mainland, the possibility for the vast sums of retail wealth to flow into crypto will maintain a positive sentiment off-set to US-driven FUD 💪.
Positioning remains supportive…
Meanwhile, the latest fund manager survey from Bank of America continues to show funds hugely underweight equities and tech and Credit Suisse retail fund flows YTD have been heavily into money market funds, out of equity. Despite the recent correction, positioning (or lack thereof) should continue to support a market that has missed the YTD gains.
Spot/Vol Correlation Strong
The positive spot/vol correlation saw vols get hit as spot crypto came lower, with the sharpest decline in implieds on Friday, taking one month ATM BTC vol down from 58v to 46vol over the week and “catching down” to realized vol which has flatlined as the pump higher has stalled.
BTC “skew” is relatively flat, but still trades better bid for calls over puts, pointing to more positive sentiment.
Perhaps interesting, given the Hong Kong June “go live” for retail, our largest block flows in both BTC and ETH were buying June upside “wings” while selling the ATM strikes. 👇
2500x June 45k Calls bot (~60k vega)
500x Jun 27k Straddle sold (-$55k vega)
250x Jun 24k Straddle sold (-$28k vega)
10k Jun 2500 / 3500 CS (sell 1x / buy 3x)
These “convexity” trades will perform with higher levels of spot and vol. Positioning and flows then continues to look for upside in the medium term, even if short term we’ve seen selling of near-date calls and vol.
TLDR: Cautious in the short term, but no sign of a material change in a more positive medium term outlook.
The rapid rates reprice on the stronger data throughout Feb has seen a retrace of many of the crypto positive cross-asset Jan moves which leave us at some pivotal levels in rates, real rates and the dollar.
Crypto continues to out-perform, with improved liquidity a powerful off-set to a more concerning rates dynamic. However, with broad commodities pushing to new lows in Feb and given some of the seasonal adjustment issues in Jan, it feels the market has run ahead of itself in pricing out a peak inflation, peak rates narrative.
In crypto, there’s been no major scramble to position for deeper downside correction and so little reason to pivot on our bullish outlook for 2023. Nonetheless, we remain mindful that we’re sitting at some pivotal levels across rates and the dollar. March data for Feb will also be essential to determine if Jan’s data bounce back was just a blip to a trend of slowing growth and inflation.
We’re watching and waiting.