Federal Reserve Chair Jerome Powell speaks during a news conference at the William McChesney Martin Jr. Federal Reserve Board Building following a Federal Open Market Committee meeting on Wednesday, July 26, 2023, in Washington. (AP Photo/Nathan Howard)
Copyright 2023 The Associated Press. All rights reserved.
Overview
The consumer price index rose 0.6% in August, its biggest monthly gain in 2023. Gasoline prices, which had a 10.6% jump, were the primary culprit. Despite this seemingly ominous news, stocks, indexes, bitcoin, and other digital asset prices reacted positively in the immediate aftermath – bitcoin broke over $27,000 on September 18th. This somewhat surprising market reaction shows an expectation that the next Federal Open Market Committee meeting will still see a stagnant hold on the rates, a bullish sign.
Fed watchers expect the FOMC to hold rates steady
CME Fedwatch
Key Background
The Federal Reserve has hiked interest rates 11 times since March 2022 as it seeks to soak up excess liquidity in the market from its pandemic-driven trillion dollar stimulus programs. Year-on-year inflation reached a 40-year high of 9.1% in June 2022. While it has come down considerably, the annual raise is now just 3.6%, persistent inflation and uneven movement across sectors make the tightening policy harder to calibrate.
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At the July Federal Open Market Committee meeting, which saw the target federal funds rate increase by 25 basis points to 525-500, Chairman Jerome Powell demurred on giving forward guidance. He gave similar, albeit more bearish comments in August at the Jackson Hole Economic Symposium.
Across the world, central banks are taking similar steps, although not at the same pace. The European Central Bank delivered a new round of interest hikes, bringing its rate to a record 400 bps, and its President, Christine Lagarde, signaled that there was more coming. The Bank of England is experiencing a similar scenario as the Fed meets this week as well, with expectations of its own 25 bps hike.
During this historical hike cycle, which would have weakened bitcoin under normal circumstances because it is seen primarily as a scarce asset, prices remained buoyant with tech stocks. Yet even that may be surprising. Tech stocks should have suffered, because higher rates on fixed-income products devalue the worth of future profits for companies such as Alphabet and Meta, but that has not happened.
This is just more evidence of the unorthodox nature of today’s market, which has also led to U.S. bonds experiencing an inverse yield curve since mid-2022, where short-term bills are yielding over 5% compared to 4.33% for the 10-year expiration and 4.41% for the 30-year respectively.
Treasuries have faced an inverted yield curve for almost a year
yCharts
Outlook
The prevailing sentiment is that while the Fed will hold rates steady tomorrow, it will likely hike rates another 25 bps in either its November or December meetings to reach a terminal target of 550-575 bps. After that, the debate turns to when it will start to reduce rates. Originally projected for late 2023, expectations now put the first reduction into the middle of 2024.
However, just because bitcoin has seemingly reacted positively to hikes over the past year does not mean it will do so in the future. The chart below demonstrates that the world’s largest digital asset has a low (or even inverse) correlation to rising rates at times. In fact, it is now the lowest that it has been since last winter. This suggests that bitcoin’s movement right now is due to more endogenous factors, such as the market still recovering from the fallout in 2022. This should be expected to a degree, given that bitcoin and digital assets are supposed to represent an alternative asset class that should be uncorrelated.
Bitcoin’s correlation with 10-year treasuries is its lowest since early 2023
TradingView
Do not be surprised if bitcoin and other assets see a temporary bump after the announcement, but also don’t be fooled into thinking that it will last. A positive move like this could also be caused by the need for traders and funds to rebalance their portfolios in preparation for a hike in November, and a final hawkish forecast for 2024 in December. However, it’s difficult to see this rebalancing turning into a massive long bet, especially since this allocation usually doesn’t exceed 5% of the assets under management and is reduced as soon as the asset hits specific targets.
Decision Points
Besides long-term bonds with these supposed new yields as the possible winners, it might be a good moment to take short positions in digital assets or indexes that also might suffer soon, betting on a quick retreat after Q1 2024 and a final shift in mid-2024. Even if you are long these assets, taking the other side could provide some hedge.
In the absence of a bitcoin ETF decision, or some other major piece of stimulus, we could be looking at a continued bearish end of the year. This could mean that it is worth buying some put options on assets if priced favorably. That could be an interesting hedge even if people go long bitcoin with its halving about to happen in April 2024.
