After a tumultuous week in markets and especially crypto, I thought I’d share some thoughts and give some perspective on how I’m thinking about things within a bigger picture macro framework.
The broad fear right now is that spot inflation is forcing central banks to tighten irrespective of whether it causes recession. Yes, they’re clearly panicked by inflation and facing political pressure to address it. There’s also talk that the Fed wants stocks lower to deflate bubbles.
That may be true but the fact is, in credit driven economies, the only way to grow with real wages falling is to keep expanding credit and to do that, you need high asset values which is the collateral underpinning the system against which consumers and businesses get leverage and drive growth expansion.
The feed through from declining asset values to credit contraction hits leveraged economy growth very quickly and we fall into recession and a deflationary bust.
The Fed knows this, but the problem at the moment is that they don’t see any material growth slow down and for all of the models they use, they really only respond to data as it hits. Many market indicators meanwhile are pointing to a sharp growth slowdown, if not outright recession.
The cure is worse than the disease!
Over the next few months, the growth outlook will regain focus as the data deteriorates (Q1’s negative GDP print effectively overlooked at this point given the “transitory” factors pulling it lower) and the Fed will be forced into a dovish pivot/pause.
The fall in demand alongside base effects will bring inflation sharply lower during that pause and then we’re back into a cutting cycle.
If the Fed really wanted to flush out leverage and allow a reset, they’d have done so in 2008 but it’s an impossibly difficult decision to take, to let a 1930s style depression take hold, so I think it’s low probability the Fed will allow that all in the name of fighting inflation. The cure is worse than the disease! I also think we’ll trend back to a disinflationary environment.
So this leaves me thinking we’re at peak Central Bank hawkishness.
The long bond trade is just beginning to get under way in the long end and will begin to get more pronounced in the front end (the market is already pricing cuts in 2023). Stocks/risk will remain volatile as the markets and Fed diverge on the appropriate rate path but the Fed will eventually get what the market is telling them on growth as the data flow deteriorates (the “soft” data is pointing lower).
A lot of bad news is already baked in
So potentially we’ll experience more downside in equities as we manage the balance between the market pricing a lower terminal Fed funds rates against fears of the Fed over tightening into a recession, although a lot of bad news is baked in at this point. Long bonds look attractive here. Crypto trades as a high beta risk asset with the LUNA/UST blow up creating additional problems which will perpetuate some of the FUD around crypto.
Longer term, I believe we’ll revert to a low growth, low inflation world supported by low rates and ever expanding central bank balance sheets and the subsequent fiat debasement will keep pushing “assets” higher.
Crypto meanwhile is building the platforms and protocols for the digital age and is an asset class in its infancy. High volatility, exponential upside. For non traders, don’t take leverage and only allocate a proportion of your portfolio that can stomach these large drawdowns.
So my point. Don’t “trade” these markets and don’t panic. The longer term drivers remain intact from a broad macro perspective.
In crypto, we just keep building!
David Brickell is Director of Institutional Sales at cryptocurrency broker Bequant.
