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You have probably heard the investing mantra "Don't fight the FED", but what does it actually mean & how does it relate to the crypto markets?
A thread
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The FED & FOMC make decisions regarding interest rates and assets purchases/sales (QE/QT) in order to achieve their goals. Namely, economic growth, price stability & employment.
Don't fight the FED means you should align your investments with the monetary policy of the FED
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So how do interest rates effect the economy?
Generally:
Raising rates makes it more expensive for businesses to borrow money
Lowering rates makes it less expensive for businesses to borrow money
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With inflation breaking reaching 40-yr high of 8.5% in March, the FED is forced to raise interest rates.
Let's look at what is likely to happen:
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1. Rate hikes
2. More expensive for consumers/ businesses to borrow
3. Cost of debt increases therefore
4. Lower consumer spending & Biz profits
5. Lower profits mean Biz spend less & reduce investment
6. Lower employment
This all acts to slow the growth of the economy
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The FED has hiked rates many times in since it's inception in 1913 .
Here is a historical look at the Federal funds rate over the last 62 yrs. Highlighted in blue are recessions.
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Quick recap:
March - 25bps
May - 50 bps
June & July expected - 50 bps
Then, 25bps until end of 2023
The market is therefore expecting the federal funds rate to be 2.5% by end of 2023.
However the FED isn't just raising rates...
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They are also starting quantitative tightening (QT).
QT is essentially the opposite of QE & it will begin next week (Jun e1st) at a rate of $47.5 bn/M, looking to scale up to $95 bn in 3 months.
They performed QT at a rate of $10bn/M in 2018 & equities fell hard
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We are doing QT at a pace that has never been seen before, all whilst raising rates.
In 2018, we started with $10 bn/m and slowly got up to $50bn/m at year end.
Consequently the market nuked a few months after QT
Now QT is set to start at the maximum level of 2018...
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So how will this effect Crypto assets & the market in general?
Firstly, we should understand that currently the crypto markets are highly correlated to tradfi & are acting like 'risk-on' assets.
As such, the 40-day rolling correlation between the Nasdaq &
Btc is at 0.89
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By comparing the reserve balances held by FED banks & the amount of margin in customer securities accounts, we can get an idea of how banks lend & provide liquidity to the system in different macro conditions.
We can see there is a high correlation between the two.
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Comparing this to the tradfi markets, we can get a sense of how the reserve balance / customer margin shows up in markets.
The debit balances of customer securities margin accounts seems to be a leading indicator for the NASDAQ, showing high positive correlation.
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When the FED balance sheet expands, there is more margin borrowing & stocks tend to do well.
Once the FED starts draining their balance sheet, banks will tighten up their lending & margin levels will fall.
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As the FED shrinks it's balance sheet, reserve balances held with FED banks will be decreased & this will shrink the amount of leverage in the system. Likely negatively impacting stocks & crypto assets.
S&P500 vs Reserve balance for reference
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With #Btc being invented in 2008, crypto has never really existed in a recession & so it's anyone's guess how it reacts.
However, with the high corr. to equities and risk-on assets, we can assume crypto will perform badly if the wider market performs badly.
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Please let me know your thoughts / if anything is wrong!
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