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Last week’s hawkish dot plots pushed interest rates and the dollar to new highs; with the “higher for longer” narrative and equities and bitcoin flirting with year-to-date lows, markets are now at a “crossroads”.
- A second week of declines and drama has markets at a “crossroads” near year-to-date lows, we discuss risks and catalysts into the end of the year
- The Fed reiterated their fight against inflation in last week’s announcement with dot plots that illustrate even more “higher for longer”, despite the continued move lower in US breakeven rates
- The dollar strength experienced over the last year is, in fact, “extraordinary”; given the fifth largest one-year move in DXY history, bitcoin remains resilient
- While the dollar remains a headwind, bitcoin’s bottoms often coincide with major DXY tops
THE BIRD'S EYE VIEW
The final weeks of the third quarter have not been without volatility, as market drama and a change in sentiment for the worst has resulted in another two weeks of negative price action.
Last week’s FOMC meeting was the talk of the town in which Fed Chair Jerome Powell raised the benchmark policy rate by the expected 75 basis points, the third consecutive move of this degree.
But what was unexpected is what moved markets. The Fed’s median projection of policy rates by the end of next year came in at 4.6% - this was higher than the 4.4% terminal rate expectation and also meant there will be no rate cut in the second half of the year.
While lower commodity prices, yields, and inflation expectations in the summer lead to a bounce on the possibility of less financial tightening, this announcement was a harsh reality that the Fed is serious about avoiding the problems faced from cutting too soon in ‘70s.
As a result, two major stress factors – both interest rates and the dollar - moved to new decade highs, sending risk assets and bitcoin to nearly year-to-date lows. Some major and relevant macro movers of last week listed below:
This latest round of fear and panic has brought the S&P 500, the Nasdaq Composite, bitcoin, and ether down to just 0.7%, 2.1%, 6.3%, and 43.1% from the lows experienced in mid-June, as of Sunday’s close. As a result, the group is again down 22.5%, 30.5%, 59.2%, and 65.0% on price year-to-date:
So, as the macro storm continues, risk assets find themselves at a crossroads headed into the end of the year. Will stress factors such as the dollar and interest rates maintain their stampede as the Fed hikes until satisfied, or are fears officially overdone, setting up for not only an attractive long-term opportunity, but short-term as well? Only time will tell.
All things considered, bitcoin and ether continue to trade around the ~$19,000 and ~$1,400 closing 2017/2018 highs, which remain key levels for overall progress in the big picture.
As we know, volatility is nothing new for crypto and equities, particularly through Fed hiking cycles. While difficult, those that remain patient have often been rewarded.
With the “higher for longer” narrative and a surge in the dollar as increasingly important thematics, we deep dive these themes on page 2, 3, and 4 of this week’s weekly.
HIGHER FOR LONGER
While the data throughout the Summer had some participants believing a “Fed Pivot” may occur, the Fed’s recent FOMC announcement and Q&A session illustrated the group of policymakers has other plans.
Headed into the FOMC announcement, the market expected a peak policy rate of 4.4% by May of 2023 and an ultimate cut by September.
But the “dot plots” illustrated the median Fed member preference of a 4.6% rate by the end of the 2023 year, appearing to have pushed back the “Fed pivot” until 2024.
This more hawkish than expected announcement sent interest rates and the dollar higher, and as a result, risk assets lower.
The Fed’s median projections of 4.6% by the end of the 2023 year illustrates a more tangible sign of a possible policy error, particularly as breakevens imply lower inflation to come in 2023 (we continue below).
Despite the Fed’s plots, participants still price in a cut around November or December of 2023.
Whether the Fed can reach and maintain this 4.6% expectation (~150bps higher with 4.75% upper bound) will be a theme going forward, with any signs of relief likely to benefit risk assets, with crypto included.
POLICY MISTAKE IN THE MAKING?
It appears even the Fed has lost patience with their inflation fight with an increasingly hawkish tone as of recent.
To put things in perspective, markets priced in a 3.15% policy rate by June of 2023 back in July of this year when the Fed Funds Target Rate was just 1.75%.
In less than three months, the Fed has already reached that 3.25% level, with expectations they could hike to 4.6% by June of 2023.
This is where the policy mistake may occur. Breakevens have priced in decelerating inflation for months (1yr breakeven peaked on March 23rd at 6.31%), and now expects inflation to be below the Fed’s 2% target, by the end of the 2023 year.
This starkly contrasts the “higher for longer” narrative the Fed has argued in recent weeks. While Chair Powell has reiterated the importance of “higher for longer” in consideration of the mistakes made in the ‘70s, it could be tough to maintain this stance if inflation were to ease as expected by breakevens.
EXTRAORDINARY DOLLAR STRENGTH
The strength seen in the US Dollar is not to be ignored: alongside a two decade high in the DXY Index, the 365-day rate of change is on par with some of the largest moves in DXY history.
This year’s dollar strength has reflected factors such as: 1) a relatively strong economy versus the rest of the world, 2) a faster hiking cycle and thus, attractive interest rate differentials, and 3) the dollar’s safe-haven status in times of uncertainty.
Given 1) that the dollar is the base pair for bitcoin investors based in the United States, and 2) the interest in safe-havens versus speculatives, this strength has been just another headwind for digital asset investors.
To put things in perspective, the 21.6% move compared to just one-year ago ranks as the fifth largest 365-day move since the DXY was created in 1967, and compares against:
- 1981’s hike cycle
- 1985’s pre-Plaza Accord
- 2015’s hike cycle
- 2009’s safe-haven status
- 2022’s hike cycle
When adding this to the heuristic list of “all things considered,” bitcoin’s 1-year decline of 55.7% illustrates resiliency throughout this extraordinary macro storm.
USD – AND THEN WHAT?
Even when considering the printing of $6+ trillion since the Covid pandemic and the subsequent “late and large” Fed hiking we’re now experiencing, the dollar continues to strengthen against other major fiat currencies.
Whether this is dollar strength or rest of-the-world weakness, the dollar has again found itself as the “best house in a bad neighborhood.”
But considering the trajectory other major G10 currencies, where is the “next best hideout?”
Not only has the dollar strengthened against every major G10 since the Covid pandemic, but it’s also gained against all majors since 2012.
When including bitcoin into the “G10” – we see one asset that has outperformed the dollar, bitcoin.
This continued weakness in other currencies is a long-term tailwind to bitcoin, an alternative monetary asset with an objective, hard-coded monetary policy and sovereign independence.
DXY PEAKS COINCIDE WITH BITCOIN LOWS
As the dollar index (DXY) attempts another leg higher, we consider the impact for long-term bitcoin investors.
Historically, bitcoin has rallied when the dollar falls, and has fallen when the dollar has strengthened (among other factors). This “makes sense” given the USD is the base pair for bitcoin investors in the US, as well as the understanding that dollar weakness often reflects “risk-on” trading.
Thus far, the dollar has rallied 26.6% from the lows on January 5th, 2021 to Friday’s close, which is much stronger than the dollar rally experienced from 2018 to 2020, which included both tariff wars and a rising rate environment. In that period, the dollar strengthened 16.1%, and bitcoin declined 39.9%.
Now, the dollar has strengthened 26.6%, with bitcoin down 44.1% in the same period. Given that this year’s dollar strength is much-to-do with a hawkish Fed and the dollar’s safe-haven status, a change in either of these can lead to a pause and pullback in the extraordinary strength seen in the DXY (illustrated on page 3). Similar to the 2015 and 2020 post-dollar-strength eras, we’d monitor a reversal in the dollar for signs of a more definitive bottom in bitcoin.
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Joseph Orsini, CFA, CMT
Vice President of Research
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