A Little Bit of macro and a Little Bit of Crypto
Macro – Not so fast?
Post the December shift from the FED to indicate that, via their dot plots, they expected no more hikes this cycle we saw traders quickly price in 140-150 basis points (BP) of cuts by the end of 2024. The FED itself projected that it would move its policy rate by only 75 BP which is three standard rate cuts over the same period. We may get more clarification post the FOMC this week. Interestingly out of the gates FED speakers all this month have been trying to temper this enthusiasm for easing which has led to a much looser state of financial conditions and subsequently higher asset prices. The last moving piece is of the puzzle that seems to be in play is the extent to which they adjust the pace of Quantitative tightening. There is an expectation that Fed officials are to start deliberations on slowing, though not ending quantitative tightening as soon as this upcoming policy meeting. The moves by the FED it seems are less to do with what the current signals were telling them and more probably to do with reducing the overly restrictive cash rate and trying to navigate their way through the end of the BTFP (Bank Term Funding Program) which is confirmed to end in March.
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There are three lingering issues that may throw a wrinkle on their easier stance.
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Persistent inflation
Inflation prints in the West, while on a general downward trajectory, still exhibit a few problematic traits. Most of the decline in inflationary impulse was in goods inflation. This was driven by normalising supply chains and the ability for countries to find new paths or markets for their goods in the case of trade barriers (Tariffs and sanctions). Services inflation globally remains a problem, demographics and excess savings have seen employment participation levels stagnant. Zero goods inflation, or disinflation in some months, saw total US annual core inflation ease from 6.6% from late 2022 to 3.9% by the end of 2023. However the Services component, while falling to 7.3% in early 2023 remains at a relatively high 5.3%. This theme is played out globally. In the UK core goods inflation has been circling zero for the second half of last year however core services inflation remains elevated at about 5.5%. Similar patterns are present in Australia.
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Resilient Growth:
The economy is still growing, US GDP came in at an annualised rate of 3.3% for Q4. In the data there were a few interesting themes as well. US government spending was significant. ?So far, more than $US100 billion in student debt cancellation has already been approved and implemented. That could have been responsible for a good deal of consumption in the fourth quarter. Another driver of consumption was continued drawdown of consumers’ personal savings. That savings rate fell to 4 per cent in the fourth quarter from 4.2 per cent in the third. The long-term average is about 8 per cent. There are few negative signs lurking in the shadows that all is not well with the US consumer. Credit card delinquencies are rising as are auto loans. As mentioned the extent to which growth in budget deficits remains buoyant outstripping GDP is worthy of note. (chart 1). If the economy slows the trajectory of budget deficits will only be in one direction which leads us to the third problem.
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Fiscal Support remains robust
This fiscal support in many ways fights against the near term goals of the FED. The generally Dovish FED governor Chris Waller spoke during the month. The FED and others have been painting the narrative inflation was largely a supply chain issue, a covid phenomenon. He seems to have broken ranks. “"If these are temporary supply shocks, when they unwind, the price level should go back to where it was. It's not. Go to Fred. Pull up CPI. Look at that thing."… he also reflects that the argument made many in the MMT (Modern Monetary Theory) camp are misplaced in their views as well. “Well, just from a simple macroeconomic point of view,? if you’re going to increase the spending in the debt by $6 trillion in a matter of two years and then say that it has no effect on demand - that seems impossible to me”. The FED and the treasury have an unenviable task to manage the level of rates and financial liquidity in the face of continued likely high levels of fiscal support and requisite debt issuance that potentially fans the inflationary impulses still flickering in the economy.
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Managing liquidity is a different problem but none the less significant. The FED and treasury are in need of a plan for the ending of the BTFP (Bank term Funding Program). This month the FDIC and FED prepared the market indicating they are likely to introduce a plan to "require" that banks tap the Federal Reserve’s discount window at least once a year to reduce the stigma of using the facility. This would mean hopefully that the participants tapping the window for funds can be obfuscated and mingled with those that don’t need it and reduce the risk of a bank run such that we saw last year. This was also a policy in place in 2008 when banks were encouraged to access funds even if they didn’t need to in a display of solidarity with those that were in genuinely in trouble. There is a saying in politics and policy that “there is a nothing more permanent than a temporary solution” The FED, Treasury and FDIC seem intent to try and make that not the case with the BTFP.
?Ample liquidity is key to navigating the banking sector through the transition to a world without a BTFP. Currently, the Fed allows around $US75-80 billion of US government bonds and mortgage-backed securities to mature each month, without reinvesting the proceeds. Letting these bonds mature and roll off the Treasuries balance sheet is often referred to as Quantitative Tightening. The economy has dealt well so far with rate hikes and Quantitative Tightening. There is a growing expectation that the Fed will reduce the pace of the “run off”, which theoretically will also reduce that upward pressure on rates. In 2019 the FED also tried to transition from Quantitative Easing which caused huge liquidity dislocations, the Fed is clearly concerned that this current pace of quantitative tightening could disrupt the efficient functioning of money markets, forcing it into a potentially embarrassing policy reversal.
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Recapping the view –
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The picture this paints is one of volatility and opportunity in global markets over the coming quarters.
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Crypto is officially mainstream -
Bitcoin
Irrespective of the price performance of BTC post the launch of the ETF by the issuers will be viewed as a resounding success. Volumes were significant which I will deal with briefly below and the trading of the various ETF offerings indicated that there was a general level of comfort with the paper representation of the physical BTC asset. The issue that crypto Assets have had over the last 18 months has been access to new capital. Banking rails were impeded through operation Choke Point 2.0 and the stigma post the various bankruptcies had driven many away from the space. This version of the asset, while far from a stamp of approval from everyone, as there is still a great deal of resistance from some quarters, does allow an easier point of entry into the space. This will see a change in sentiment from of those providing financial services to the blockchain and crypto related firms over time. I will deal with a few issues below including the structural tailwind of institutions selling of BTC, will the BTC ETF stifle or amplify the decentralised narrative, what the flows this month are really telling us, and lastly the likelihood of an ETH ETF being the next cab off the rank.
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Headwinds or tailwinds?
Large institutions move slowly, the idea that they would have been already selling a product that remained so contentious up until the very end is ludicrous. The SEC were forced by the courts to approve the ETF, the chair Mr Gensler voted yes to the ETF being issued and in his statement post indicated that the SEC, that he chairs, has a dim view of the asset still. Its largely based on views that remain contentious inside and outside the community revolving around the purpose and use cases for digital assets. While Mr Gensler’s stance is one that remains sceptical others in the commission, notably Hester Peirce, were critical of the negative stance of the SEC and disappointed that their stance had alienated the industry.? From her statement “we have alienated a generation of product innovators within our space. Our unreasonable approach to these applications has signalled that regulatory prejudice against new products and services can lead us to sidestep the law and unreasonably delay product launches.”
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With the launch out of the way the process to begin selling the asset has only just begun, internally distributors conduct their own reviews before approving any product, this anywhere from 1-6 months. Some will embrace it others less so, Vanguard for example indicated that they would not allow the BTC ETF to be sold on their platform, they however do allow Microstrategy shares that are essentially just a BTC tracker at this point, they allowed the BITO product which was an ETF based on futures and they facilitate trading in BTC miners. As you can see there is a great deal of inconsistency in approaches and also a huge amount of heavy lifting that needs to be done to educate people regarding the role that digital assets can play in a diversified portfolio. The moral of this story is that while slow moving the marketing has started – Blackrock’s advertisement is a great example of who is being targeted, the investors with money, they need reassurance, a calm voice and simple explanation which is a far cry from the meme centric crypto twitter platforms that have been the norm. The institutions are coming, but they remain in the early stages.
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Money equals influence
One of the core tenets of the BTC and crypto in general is decentralisation. That is that no one institution or individual has an outsized say in the network. The fear is that centralization through proxy government control and regulatory capture of a portion of the underlying assets can have an influence on the network. There is fear that with enough control one day authorities could shut it down or seize assets held by custodians is a fear that pervades in the extremes. Given assets held in this format are currently $27bn and the value of the asset is $820bn we are a long way off that issue.
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The involvement, capital and engagement of centralised actors is an interesting development, for sure it has the risk of the above however it also potentially has a positive impact through adoption of some of the core positive tenets of blockchains. Transparency for example; The Bitwise team have listed their ETF address and wallet for us all to check to ensure the assets are there. The idea of transparency is a core theme of blockchains as is trustlessness. Technology carrying out the verification which in turn reduces the need for expensive custodians, auditors and other players is a positive. There is a risk that inviting a large pool of capital into BTC and digital assets can at the extreme see them co-opt the asset class, but equally the money and the validation that adoption brings can improve the financial system improving access, efficiency and reducing pointless choke points and valueless rent seekers.
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Inflows vs outflows
The flows from the launch date have been significant. The launch was unique in that there was existing funds in the ecosystem trapped in inefficient vehicles and structures (Greyscales GBTC product) that could now leave the system entirely or be transferred to cheaper ETF’s. GBTC had formed a huge part of the trading ecosystem for a long time with AUM around $26bn pre the ETF conversion. Being a closed trust it allowed access to the asset class when there was really none, however the downside was that exiting the product difficult and expensive. In the bear market the product at a large discount to the underlying asset. This discount was an opportunity to a large number of professional participants in the 2022/23 buying it a discount versus the spot BTC taking the view that it would likely become an ETF and they could capture that spread. From its conversion on the 11th January they could close the trade selling the GBTC and buying back the BTC they were short. The other significant outflow was from the estate of FTX who also sold $1bn of shares, whether they were converted to cash or an ETF remains unknown but one would assume the former is more likely. The last and significant headwind to GBTC retaining funds is the fee, a whopping 1.5% (down from 2%) compared to fees from 0.20%? to 0.25% for its rivals. As can be seen in the chart below from Farside investors there has been a significant outflow from GBTC ($5bn) that’s been more than offset by inflows into the other ETF’s. There is limited transparency how much of the flow into the new ETF’s is rotation from GBTC or other brokerage accounts versus new inflow however the fact that the net flows have been positive to the tune of circa $800m, is positive. The “trapped” assets be they bankruptcy estates (FTX or Mt Gox) or the GBTC trust are slowly being removed, eliminating the overhang as we move towards the halving is an interesting dynamic.
Ethereum next?
The final fallout from the ETF launch is the speculation of when and if an ETH ETF will be launched, the timing and the likely objection from the regulators. Hester Pierce indicated that the SEC will not be waiting for a court case specifically regarding an ETH application before approving an ETF she indicated “that’s not how we’re going to do our approvals.” “We need to just be applying regular [consideration] to these products. The same kind of consideration that we apply to similar products and, so, we shouldn’t need a court to tell us that our approach is arbitrary and capricious in order for us to get it right,” she said.?It’s important to note however that she is one voice inside the increasingly politicised Commission.
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The next date for a final acceptance or approval could be as soon as May. 21 shares and Ark have applications in that need approval or denial by that date. Bloomberg ETF analyst Eric Balchunas believes that a final decision will be made on all pending spot Ether ETFs in May, with the analyst giving a 70% chance of approval currently. ETH has a great deal of the same traits at BTC however interestingly through the staking mechanism does generate a yield which could see the SEC view the asset through a different lens.