Cryptoverse Weekly #2: Crypto deja vu 2018? Interest Rates expectations appear to be peaking out

Interest rate hike expectations appear to have peaked and with it, financial markets might start to price in recession risk - lower bond yields might confirm this view. While the Fed hiked interest rates by +75bps to 1.75% in June 2022, expectations that the Fed Funds rate would increase to 375-400bps by June 14, 2023 (one year from now with roughly four 50bps rate hikes each time) decreased from a probability of 90% to 50%. While the market still expects rates to rise, the magnitude and the certainty of those hikes are coming down.

Risk assets (among them digital assets) might start to see this positively.

The market is indicating that those rate hikes will cause enough economic destruction, and therefore Treasury yields closed lower while WTI oil prices dropped by -10% last week. This view remains valid if oil prices remain below $120 and 10-year Treasury yields remain below 3.40%.

Similar to January 2018, Bitcoin lost upside momentum once the upside trajectory for the 2-year treasury yield was well on its way higher (dotted grey lines, chart below) with Bitcoin’s bottoming process starting to establish itself (one month later) after short-term interest rates peaked out (black line) – signalling less restrictive monetary policy was required.

We would argue that we have reached a similar point now where a potential last 'recessionary' decline could present a buying opportunity.

Back in November 2018 when two-year treasury yields peaked out, the recession risk caused Bitcoin to drop from 6,406 to 3,183 until the December 15th, 2018, low was in place. Back then, the Fed was also very confident about its hawkish interest rate outlook as well as its quantitative tightening approach which meant shrinking the Fed’s balance sheet.

Two-Year Treasury Yield (LHS) vs. Bitcoin (RHS)?

Let's zoom into the Nov 2018 interest rate peak and Dec 2018 Bitcoin low

Since the global financial crisis in 2008, there has been a broad misconception that central bank balance sheet expansion, through policies such as quantitative easing (QE), would cause inflation. But without the velocity of money actually rising, QE was never inflationary, and therefore bond yields continued to decline. This misconception was carried over into the crypto market where some have argued that Bitcoin is an inflation hedge.

But the monetary hedge of crypto was primarily against a devaluation of the currency through endless money printing, expressed through an extension of the money supply growth. 40% of all the USD being issued in the history of the United States, were issued during the two years of covid emergency measures and those policies have come to an end now. It is not inflation that matters, its expansionary fiscal and monetary policies.

In fact, financial conditions have tightened materially through a mix of higher interest rates expectations, elevated energy prices, lower equity prices as well as a relative upward repricing of the US Dollar. The monetary tailwind which has been in place since December 2018 has indeed peaked out in April 2021 and was gradually replaced by monetary headwinds where the lagged impacts of Layer 2s and NFTs gave digital assets some further extended upside momentum. The monetary signal has been quite bearish for crypto for some time now (grey line, chart below).

Bitcoin when US Money Supply Expands vs. Contracts?

But as the first chart indicated, once the rate hike expectations peaked out and a ‘recession [price] leg lower’ is priced in, crypto might very well be off to the races again. With last week’s Fed meeting, rate hike probabilities are being dialed down and a decline in oil prices might indicate a recessionary environment.?

Watch out for this year's 'December 2018' moment when the market perception changes and the low is in.....

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