Three weeks ago, I wrote an article called Maelstrom, in which I described a thought process for rationalizing my crypto portfolio by holding only Bitcoin, Ethereum and Some altcoins that I have faith in.
While many appreciate my candor and opinions, some have rightly pointed out that my bearish article was published a few weeks after Bitcoin and Ethereum dropped over 30% from ATH. These are my essays, and I hope they are persuasive, backed up by logic and evidence. I’m not here to help you accurately grasp the rhythm of the market, but to challenge your point of view, and I hope to help you grow as a trader or investor.
The crypto capital market is the last free financial market on earth. All other major asset classes, and the intermediaries that help people trade these products, have become political targets of governments and central bankers. “When a measure becomes a goal, it ceases to be a good measure” – Goodhart’s Law.
Equities, fixed income, and foreign exchange markets are deeply influenced by central banks and those too-big-to-fail banks. This means they can run unlimited leverage on the taxpayer’s back, with the consequence of inflation caused by wanton money printing. The balance sheets of these banks are used to fix asset prices at levels that achieve political equilibrium. This benefits the wealthy because in any society, ownership of financial assets is highly concentrated among the richest 10% or even 1% of citizens.
Cryptoassets are completely outside the TradFi system and thus find a level of market liquidation before stocks or bonds. Cryptoassets are now a true asset class, traded by ordinary people like us, hedge fund gurus, and a handful of sell-side banks. As the last truly free financial market, crypto-assets will find a liquidation price that reflects the current macroeconomic environment, up and down, sooner than all other assets.
My belief in the above point of view presents me with a dilemma.
The first three weeks of the year saw a sharp drop in the crypto asset market. US stocks — the S&P 500 and Nasdaq 100 — are just below their all-time highs. The stock market certainly hasn’t entered a true bear market. But the capital losses suffered by crypto-asset holders suggest that the removal of dollar liquidity by the Federal Reserve in a new round of action to fight inflation will hit stock index holders in the short term.
This is good. But the Fed hasn’t even stopped buying bonds or raising policy rates. If I wait until the March meeting when the market predicts the Fed will raise rates, will I be too greedy and miss a great entry point to trade dirty fiat for clean crypto? I can’t deny that if Bitcoin trades below $30,000 and ETH trades below $2,000, my finger on the buy button will be very excited. But does this eagerness match the probability map I have in my head about the future?
This article attempts to give people more flexibility in deciding when to buy the dip.
The U.S. president held a separate press conference last week and affirmed that it was the Fed’s responsibility to curb inflation. Whether or not you believe the Fed is 100% responsible for high inflation in the US and can do something with their policy levers, the Fed has to raise interest rates on policy. The Fed is never 100% committed to any policy, and they always leave room to change their minds in the event of a major event in the financial markets.
The question becomes: Can the Fed publicly change its future restrictive monetary policy ahead of its March meeting? At the March meeting, everyone expected the Fed to raise the policy rate by 0.25%. Here are three scenarios in which the Fed might change the direction of policy:
1. The S&P 500 and Nasdaq 100 are down at least 30% from their all-time highs (3,357 for the S&P 500 and 11,601 for the Nasdaq 100).
2. A collapse of the U.S. Treasury or currency markets.
3. The spread between investment-grade and speculative-grade bonds has widened considerably.
I have elaborated on the importance of the first and second points to the U.S. and global economic model. It is widely believed that if either of these two scenarios occurs, the Fed could restart the money printing press against the political will of the ruling party. Less talked about is the corporate credit sector, mostly because everyone thought the Fed fixed it when it nationalized the market in March 2020.
The Fed nationalized the U.S. corporate bond market by backing all investment-grade bonds and saying it could buy speculative-grade bonds. The following two charts show how nationalization squeezed CDS spreads. The CDS spread is a good indicator of how much interest a company of a certain rating must pay to issue bonds.
investment grade basis points
In the face of a pandemic of unknown severity (changes in red), the market is starting to demand high interest payments from corporate borrowers. The Fed says “no, no, no, no” and the market is at the wrong level – let’s nationalize it by providing unlimited money printing. As a result, interest rate spreads fell, and large corporations maintained loose borrowing conditions. Unfortunately for small businesses, they don’t have access to the institutional credit market, so they get scammed. Only recently has the market started to trade sideways.
If the Fed has publicly said it will shrink its balance sheet, how can it maintain its commitment to supporting corporate bond issuance? This support must be the purchase or threat of purchase of all eligible corporate bonds as defined by the Federal Reserve. The market has recognized this inconsistency, and yields have begun to edge higher.
That’s a problem because roughly $332.42 billion worth of non-financial U.S. corporate bonds are due by 2022 (source: Bloomberg). Companies either repay investors with cash on hand or issue new debt to pay off old debt. Based on 2021 issuance statistics (source: SIFMA), the total debt that must be extended is 17% of the total annual debt.
Few companies have the pricing power to offset the negative impact of wage and commodity inflation, which is bound to shrink profit margins. So, as inflation continues to ravage America and the world, there will be less free cash flow to repay bondholders. If the Fed doesn’t aggressively curb spreads by expanding its balance sheet, the market will demand higher rates on newly issued bonds.
The most dire scenario for the Fed is that the market’s expectations of tightening monetary policy advance and demand higher and higher interest rates on corporate bonds. If companies can’t finance themselves, they reduce activity, which means losing their jobs at a very politically inopportune time. Inflation doesn’t necessarily mean someone will lose their jobs, but if a company can’t raise money because the business can’t afford the interest rates the market demands, the company will lay off employees.
I think that, politically, 7% unemployment is worse than 7% inflation. The Fed and their political brokers may soon be forced to choose between continuing inflation or facing a wave of job losses following the collapse of credit markets. I bet that loose monetary policy will return, which is positive for the crypto market as we know it. Market conditions change very quickly, and if the market believes that the Fed does not support corporate bond issuance, spreads will widen rapidly.
Rather than waiting for the Fed to publicly announce a change of heart, the strategy uses the signals provided by these indices as signs of an imminent turn. Crypto assets will capture these signals and move higher ahead of the Federal Reserve’s public announcement of its policy change.
Support: $28,500 for Bitcoin, $1,700 for Ethereum.
I don’t think the market will bottom until these levels are retested. If the support holds, that’s great, the problem is solved. If not, then I believe Bitcoin and Ethereum will drop to $20,000 and $1,300 as they get liquidated. As for Bitcoin and Ethereum falling below their 2017 ATHs ($20,000 and $1,400 respectively), I don’t want to think about that at all.
It is also possible that Bitcoin and Ethereum will not drop below $30,000 and $2,000 again and the market will never develop as expected. Then the market doesn’t have a clear test of the previous low, and the situation gets tricky. Depending on your ideological view of capital markets, you may look at one or more statistics such as: total contract open interest, net stablecoin inflows to exchanges, asset size on a particular exchange, implied volatility vs. actual volatility, etc.
One could imagine Bitcoin and Ether holding the bottom of the current trending channel when the Fed turns on the tap, but I’m sure that’s unlikely. We have to be more flexible about which signals will infuse us with confidence so that we can buy, buy, buy.
But as I write this, the market is bottomless. Traditional markets haven’t spooked the Fed, nor enough for them to stop inflation. In terms of price action, in my years as a crypto capital market participant, there have been waves of sell-offs. This past weekend was brutal, but it didn’t break the bull’s soul.
Remember, marginal sellers determine price. Institutions that hold small amounts of crypto assets will not hesitate to spit them out if their bond and stock portfolios take a hit. They haven’t started selling yet (they don’t work weekends), and the negative headlines in the mainstream financial media haven’t provided the confirmation bias these sellers need to deal with the downside volatility in crypto assets. Correlation is coming, but not yet. If the S&P 500 and Nasdaq continue to decline at the end of the quarter, watch out if it’s tied to a post by Hermès ties or pinned to the ground by Louboutin heels…
Sell skyrocketing assets to avoid further declines.
Posted by:CoinYuppie，Reprinted with attribution to:https://coinyuppie.com/the-founder-of-bitmex-issued-another-article-the-bottomless-pit/
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