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Whether en route to a soft or hard landing, central banks face further turbulence in their journey; the Bank of England reinstates a period of asset purchases after UK fiscal policy and a hawkish Fed drive rates rapidly higher.
- Just days after beginning her tenure, UK’s Prime Minister offers tax cuts during a period of rampant inflation. This move sent yields higher and the pound lower, causing the Bank of England to reinstate asset purchases in an effort to maintain financial stability
- The Fed faces a similar situation as 2018 in which the pace of Fed hikes versus the rest of the world strengthens the dollar, this time dramatically
- While equities touched new year-to-date lows, bitcoin and ether remain above their mid-June bottoms
- Strong return seasonality in the month of October could set the tone for the remainder of the year
THE BIRD'S EYE VIEW
September’s risk asset performance certainly had investors feeling like the old Green Day song, “Wake Me Up When September Ends.”
With equities now having declined six of the last seven weeks, performance has been tough to swallow: the S&P 500 fell -9.4% in the month, while the Nasdaq Composite declined -10.5%. This came as a hotter-than-expected CPI report and a tough “higher for longer” stance from the Fed soured sentiment, with equities placing new year-to-date lows on Friday, September 30th.
Bitcoin and ether’s performance, however, has been slightly different. The two have yet to put in new year-to-date lows when compared to June 18th and bitcoin outperformed equities throughout September. Bitcoin and ether fell -3.8% and -15.2% in the month and continue to trade around the $19,000 and $1,400 key levels.
Last week’s market focus was heavily to-do with the United Kingdom, in which the new government under Liz Truss announced unfunded tax cuts just weeks into their tenure. Further spending alongside an already rapid move higher in rates post-FOMC pushed British yields higher and the pound quickly lower, enough to begin rumors that some British pension plans could be in serious danger.
As a response to this rapid move higher in British yields (the 5yr gilt rose from 3.56% to 4.77% from Sep 23rd to the high on Sep 28th ) the Bank of England announced an interim bond purchase program, despite still working towards quantitative tightening goals.
Of course, this announcement worked as planned: British yields moved rapidly off their highs and the British pound retraced its initial panic-move lower by Friday’s close.
So, just seven months into a tightening process, the Bank of England needed to reinstate asset purchases.
What’s this all mean? Well, for one, it’s a reminder that central banks do in fact care about financial stability. Price stability cannot occur with dislocated and illiquid rates and FX markets, and as such, the Bank of England acted as needed.
This move also served as a reminder to investors that central banks may have an easing addiction. Fiscal policymakers continue to spend despite higher borrowing costs, ignoring the little desire sovereign bond-buyers have to “pick up pennies in front of a steamroller” in the current environment. The Bank of England quickly turned into the “buyer of last resort” yet again.
And while this is not yet a full “pivot” (the Bank of England is expected to raise their policy rate by ~120bps at their November 3rd meeting), this may serve as a wake-up call to global central banks.
Similar to the latter half of the 2015-2018 hiking cycle, US economic strength paired with rest of the world weakness has the Fed again raising rates much faster than developed counterparts. In doing so, the dollar has strengthened – and this time, at a fifth-fastest 365-day rate of change in DXY history.
So, where do we go from here?
Well, pivot or not, performance since the Bank of England news is yet another example of what can occur should the dollar and rates reverse their stampede higher. The resulting move lower in the DXY Index and yields pushed equities and risk assets higher on both Wednesday the 28th (the day of the announcement), and now Monday the 3rd, another sign of bitcoin and ether’s ability to outperform when conditions warrant.
While the Fed’s “dot plots” illustrated the expectation for a 4.6% policy rate by the end of 2023, bond traders have different plans: they now price in a 4.3% rate by the end of the year, reflecting estimates for a rate cut after peaking around March or May of 2023.
On page 2, we illustrate the Fed’s faster pace of tightening than the BoE and ECB and discuss strong return seasonality in the months ahead.
Similar to the 2015 – 2018 tightening cycle, the US has again raised rates much faster than major developed counterparts.
While tariff-wars and deglobalization were a large theme in 2018, the Fed also hiked four times in the year, compared to just one-hike from the BoE, and zero hikes from the ECB.
Now, the Fed has raised their policy rate by 300 basis points since March, while the BoE and ECB have raised just 125 basis points each.
This interest rate differential has driven large outperformance of the dollar: by the end of Q3, the pound has declined 17.5% versus the dollar, while the euro has declined 13.8% in the same period.
Will these two central banks “catch up” to the US tightening, or will the Fed remain steadfast, with further dollar strength to follow?
While Fedspeak continues to remain hawkish, some commentary of recent has noted dollar strength as a consideration, but also as beneficial to bringing down US inflation.
As we wrote last week, the dollar remains a headwind to risk assets, but major reversals have coincided with bitcoin bottoms in the past.
Markets have made it passed September’s tough seasonality and are now entering a period of historical positive returns: Q4.
In the last 10 years, October, November, and December have fared better than September for both bitcoin and the S&P 500.
Bitcoin’s average return throughout the 2012 – 2021 calendar years of 22.3% for the month of October compares to a loss of 3.6% in September, while the S&P 500 averages 1.3% in October and a -0.4% loss in September in the same period.
For the full fourth quarter, bitcoin averages a 97.5% gain versus Q3’s average of 15.3%, while the S&P 500 averages 4.6% in Q4 versus 2.9% in Q3. This is through the same 2012 – 2021 period.
Given that this has been a tough year for markets, seasonality may support renewed positivity in a world of negative sentiment.
Seasonals as a potential “invisible hand” paired with any improvements in macro stress factors could set the tone for positive performance in the fourth quarter.
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Joseph Orsini, CFA, CMT
Vice President of Research
Investment advisory and management services are provided by Eaglebrook Advisors, Inc., a registered investment advisor. Information presented is for educational purposes only and should not be construed as providing investment advice. Past performance is no indication of future results. Investing in digital currency comes with significant risk of loss that a client should be prepared to bear, including, but not limited to, volatile market price swings or flash crashes, market manipulation, economic, regulatory, technical, and cybersecurity risks. In addition, digital currency markets and exchanges are not regulated with the same controls or customer protections available in equity, option, futures, or foreign exchange investing. Eaglebrook does not offer tax advice. Neither consultations nor information published by Eaglebrook should be construed as offering or providing tax advice.
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Economic Risk: The economic risk associated with digital currency is in the lack of widespread or continuing digital currency adoption. The market and investors could decide that digital currency should not be valued at the current market capitalization due to a variety of factors.
Regulatory Risk: Digital currency could be banned or highly regulated by governments that would deter investors from buying or holding digital currency.
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