Crypto Markets Pullback While Fed Holds Rates Despite Improving Inflation Data
Crypto markets experienced a pullback this week, with Ether correcting ~10% from the local highs that were made after the SEC’s last-minute approval of the Ether ETF applications, while Bitcoin is down about ~6% from its highs. As we discussed in last week's newsletter, the amount of leverage that had chased the strong price action on Ether began to look vulnerable as momentum stalled out. We’ve now seen total open interest on Ether drop by around $2B, along with a cooling off of funding rates and a return of a spot premium.
Figure 1. Open interest has dropped by around $2 billion.
Today, during a Senate Committee hearing, SEC Chairman Garry Gensler suggested that the final steps for the ETF approvals, which would give issuers the green light to launch their Ether products, could happen by the end of the summer. However, when asked whether Ether is a security or commodity, the Chairmen declined to answer.
As crypto markets look likely to continue to consolidate, the major US indices have seen strong momentum to the upside, with the Nasdaq100 and S&P500 making new highs this week, even after the Fed held rates steady during this week's FOMC. With a softer-than-expected CPI reading the morning of the FOMC meeting yesterday, some had thought there was a chance that the Fed would decide to cut rates, following the example set by the Bank of Canada and the European Central Bank last week. These hopes were dashed when the Fed kept rates as they were and released dot plots that showed one fewer rate cut expected for this year but added another rate cut expectation for early next year. Jerome Powell came off as neutral to slightly hawkish during his press conference, where he continued to suggest more data was needed to give greater confidence in any rate cuts. Just this morning, the Producer Price Index came in cooler than expected year-over-year, along with higher-than-expected jobless claims.
With lower inflation numbers and continued downside misses in economic data over the last few months, many are left wondering why the Fed had softened their expectations for future rate cuts. It could be that Jerome Powell is giving himself more room to maneuver and not set strong expectations of cuts, especially before the US elections, to appear politically neutral. Or, perhaps it is because US equities have seen strong growth leaving Powell concerned about fanning the flames of the Animal Spirits. Although inflation looks to be coming into reach of the Fed's target rate, modest economic data might not be enough for Powell, who wants to avoid the risk of making the same mistake as Fed Chairman Arthur Burns, who cut rates just to see inflation reemerge in the 70s. Unless the US sees significant softening in the labour market, increasing the risks of a recession, Powell looks content with sitting on his hands for now. Higher for longer looks to be the base case. The larger question for risk assets is whether this rate-hiking cycle will end in a soft or hard landing for the economy (and the markets).
Figure 2. Bitcoin has seen a decline in realized volatility over the past few months.
This week marked the end of the 19-day streak of positive inflows into the US Bitcoin ETFs. Despite the significant inflows, bitcoin continues to trade in a tight consolidation just below its previous all-time highs, while realized 1-month volatility has dropped down to 40%.
Figure 3. Despite impressive ETF inflows, Bitcoin has been unable to break through all-time highs.
There has been some speculation as to why these inflows haven't been enough for bitcoin to break out and make new highs. One reason could be that the ETF flows may not all be directional. In strong uptrends, bitcoin’s traditional futures trade in contango (at a premium versus spot). Currently, the CME bitcoin futures are trading at around a ~10% premium. This gives an opportunity for hedge funds to lock in that yield by buying spot while simultaneously selling futures and then collecting the difference. Now, with an accessible US-based bitcoin product that tracks the international spot price and a liquid CME futures product, this basis-trade has become more accessible to US institutional investors and funds. It is likely that much of the recent positioning through the Bitcoin ETFs are delta-neutral, so any positive flows into the ETFs are offset by corresponding shorts on the CME.
Figure 4. There is a decent basis trade available which may be contributing to the recent muted price action.
Regardless of the reason, the lack of follow-through in Bitcoin and other crypto assets has been somewhat disappointing for investors who are watching US equities rally while crypto assets underperform. Given the fact that these recent declines have helped flush out a good chunk of leveraged positions, however, it would be a good time for investors to keenly look for signs that a mid-term bottom is forming, although further downside is certainly a risk in the near-term.
Latest Crypto Developments
In this section, we highlight the latest developments that may be significant in either the price action or the trajectory of the crypto space overall.
Bitcoin Miner Stocks Rise Following Trump’s Comments
Bitcoin miner stocks increased after Donald Trump referred to crypto mining as the "last line of defense" against central bank digital currencies in a recent statement.
Fortune 100 Companies Increase Crypto Projects
Fortune 100 companies have increased their crypto projects by 39% year-over-year, according to a report by Coinbase. This indicates growing corporate interest in blockchain and decentralized technologies.
Taiwan Forms Crypto Industry Association
Taiwan has established a crypto industry association to promote self-regulation and ensure better compliance within the sector. The association aims to create a framework that can enforce administrative penalties for violations.
EU MiCA Deadline Uncertainty
There is uncertainty regarding the deadline for the EU's Markets in Crypto-Assets (MiCA) regulation, causing concerns among industry participants. The ambiguity stems from differing interpretations of the implementation timeline.
Terraform to Pay $4.5 Billion in Proposed SEC Judgment
Terraform Labs has agreed to pay nearly $4.5 billion to settle charges with the SEC. The proposed judgment, pending court approval, aims to address the significant investor losses from the collapse of Terraform's algorithmic stablecoin, TerraUSD.
Market Returns
That's Some Good Content!
Recommended articles, podcasts, and other content from this week:
On the Margin podcast - Stocks Will Continue To Crush Bonds In 2024 | Joseph Wang
Forward Guidance podcast - “Get Used to 3-4% Inflation and 4-5% Interest Rates” | Jim Bianco on Fed’s June Meeting and Resilient U.S. Economy
Blockcrunch podcast - How We're Playing the ETH ETF - Blockcrunch Roundtable 011
The Scoop podcast - Financial advisors in the US are warming up to Bitcoin
Meme Of The Week