Introduction
- Macro is playing a more significant role in crypto price action than ever before
- This is due to more institutional players as well as an increase in the scale of central bank intervention globally
- These factors are unlikely to subside anytime soon, so a good understanding of macro is crucial to understanding where crypto is going
The correlation between crypto and the broader macro environment has been increasing for some time. As institutional participants grow in number it is natural for crypto to be considered as another risk asset within a broader portfolio and therefore be treated accordingly. However another reason for this correlation could be the increasingly unstable nature of the macro landscape we are now in. During times of broad economic stability it is easier for assets to move in idiosyncratic ways as monetary policy takes a backseat to other market forces. However, when central banks want to cause an impact, particularly the Federal Reserve, it is hard for any asset class to avoid the pressure of large changes in policy.
Key Factor
Another key factor at the moment is the strength of the US dollar. The story of this year has in large part been USD going up and everything else down (with energy being an important exception). As Brent Johnson has pointed out, due to the dollar’s status as the reserve currency it effectively acts as the denominator in the pricing equation of most assets globally. So when the dollar strengthens dramatically almost everything else suffers, including crypto. This combined with interest rates going up in large parts of the world has created more hostile conditions for risk assets than many crypto natives have experienced since entering the market. The crypto bull runs of 2013 and 2017 happened in comparatively easier times in terms of monetary policy. We are in a remarkably different environment now.
Efforts
Despite the efforts of central banks, it seems likely that inflation will remain persistently above the historical 2% target and this may in the long term be a bullish argument for crypto. Jim Bianco sets out a compelling case for how the world has fundamentally changed post-covid and that previously deflationary forces are disappearing. The globalisation of goods production, high levels of immigration into the West and cheap energy led to a suppression of higher prices over the last twenty years. However these factors have changed and there are not many signs of them reverting anytime soon. More protectionist policy looks likely and the global energy supply chain could easily remain hindered from running smoothly for the rest of this decade, depending on how quickly alternatives to Russian oil and gas can be found. Ironically governments may secretly be happy to see inflation erode some of the real value of sovereign debt. Due to current debt levels, nations are going to eventually have to default in real or nominal terms. In reality this is not really a choice; whatever the amount of fiat currency that needs to be printed to stop a nominal default will be created, no matter what the adverse effects are. The collapse of the financial system is the alternative to this. The Bank of England has already done this and eventually the same thing will happen in the US. There is a level of interest rates where the treasury market will become completely dysfunctional and when that happens the FED will be the only entity left to buy – and they will. This turning point should be bullish for risk assets and is likely to occur in the next six months or so. Despite this, the dollar is still better positioned than most other currencies to weather the turbulent times that are coming. The FED has managed to tighten financial conditions significantly more than its peers due to the dollar’s advantageous position in the world as the reserve currency.
A different angle
From a different angle, Russell Napier believes that it is governments that are fully in the driving seat here and not central banks. Fiscal policy is being run loosely in many countries despite central bank tightening. In the UK for example, the BoE is raising interest rates while the government is helping to pay people’s energy bills this winter. Similar examples can be seen elsewhere. This sort of behaviour is antithetical to bringing inflation back under control despite it being necessary to get a large portion of the public through this winter. This is a tug of war between central banks trying to crush inflation and governments attempting to limit the damage this process is doing to the real economy. Despite these loose fiscal conditions, until central banks change their hawkish stance on monetary policy it is unlikely that risk assets will rebound significantly. Because of this, the pivot so many market participants are looking for is far more likely to come from central banks breaking something fundamental in the markets and having to step in. In the US it will probably be treasury market liquidity completely drying up, although there are other areas of potential concern as well. There is also a DXY level that causes so much turmoil in international markets that there may have to be some kind of intervention from the FED. This is unlikely to be some kind of Plaza Accord 2.0 where the USD is deliberately devalued by a huge margin, however the US has less drastic levers to pull if the dollar’s strength causes too much pain. The collapse of the EUR and/or EU markets is bad business for the US due to the amount of earnings US companies derive from Europe. The FED has looked fairly apathetic to the economic pain of other countries thus far. However if this starts to seriously affect the US as well then some action could occur here. If a crisis develops that the ECB cannot solve then the FED may have to step in, despite some potential initial hesitation.
Conclusion
Given the emergence of a strong inverse correlation between a hawkish Federal Reserve and crypto, it is prudent to watch macro very closely when trading digital assets. However, the coming years may not be as clear cut as the most recent bull run, with crypto topping out very close to the announcement of tighter FED policy (which the rest of the world’s central banks then raced to catch up to). The behaviour of central banks will probably continue to give strong signals about the crypto markets future direction, however it is possible that the speed of changes to monetary policy increases substantially. It is easy to envisage a scenario where the FED has to ease substantially due to market turmoil. Then inflation ramps up and they need to tighten. Then tightening breaks something and the cycle begins again. This scenario implies a lot of volatility and shorter market cycles in asset classes across the board. For crypto this could lead to short, very intense bullish impulses that will not last as long as previous cycles. Many investors may be caught out at the speed of these directional changes and a more active style of management may be advantageous in these conditions. The most likely alternative to this market environment would be a prolonged bear market of two or more years in crypto. Perhaps macro conditions remain so uncertain that no significant risk appetite returns. Good development would continue in this time and the next set of innovative products would remain undervalued for quite a while until financial conditions improved. Regardless of the path there will continue to be huge opportunities in crypto due to the sector’s inherent volatility and the speed at which products can launch. The bull market will return. But it might look quite different to what most people expect.
