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Macro
Global markets took a sharp fall this week following Powell’s Jackson Hole speech doubling down on bringing inflation back down to 2%.
The summer rally rests firmly in the rearview mirror as investors brace for the upcoming liquidity winter from the Fed.
We witnessed a flight of safety to the US Dollar (DXY) this week as all assets down the risk curve sold off.
Markets are positioning for the upcoming FOMC rate decision on September 21st to guide the fate of the markets for the rest of the year.
Two data releases are instrumental in forming the Fed’s narrative, first being the employment situation in the NFP jobs report release(non-farm payrolls) and the second being the inflation situation in the CPI print(consumer price index).
The current meta of the market is that low CPI prints are bullish (lower inflation means less rate hikes) and low job prints are bullish (weak labor market means less rate hikes).
The jobs report came out at 315k new jobs, lower than what markets were positioning for. Participation rate ticked up and wage growth softened, causing a temporary lift in markets.
This lift was short lived however, with equities markets closing the day lower, taking Bitcoin and the crypto markets down with it.
Market’s are still expecting a high probability of a 75 bp rate hike in the upcoming FOMC, as can be seen in the implied fed funds futures rate market.
The likelihood of an early 2023 pivot has been dwindling as evidenced by the bond market. US Treasury rates have been climbing back up to multi-year highs as Powell beats the drum about the resolve in breaking back of inflation.
The famous recession indicator, the spread between the 2Y US Treasury and 10Y US treasury narrowed in the past few weeks to 20 bps down from 50 bps in light of Fed hawkishness.
Lack of Fed backstop and highly uncertain outlook suggests higher volatility likely to persist, with worse liquidity leaving markets more vulnerable to news flow.
The market has been focused recently on how the European energy crisis has been hammering the Euro. However, most of this dollar strength has been the result of the dollar being the preferred safe haven asset for this stagflationary environment.
The Dollar (measured by DXY, the relative strength vs. a basket of foreign currencies) has been on a massive tear this year, reaching 20-year highs.
This demand for dollars has been evidenced by massive rise in usage of the Fed reverse repo (overnight reverse repurchase facility) or RRP.
The Fed’s reverse repo facility can be viewed as a collateralized interest-earning overnight deposit at the Fed with zero duration and credit risk.
RRP usage has peaked to more than 2 Trillion dollars, the highest of all time.
This surge of demand tells the story of the immense demand for safe dollar assets.
This usage of the RRP has an interesting effect of reducing available liquidity in the system versus depositing into a traditional bank because the collateral requirements of the RRP is higher than that of a bank.
The strength of the dollar has been bad news for risk assets like crypto over the past year, as all purchases of risk assets are inherent shorts of the dollar.
Despite short term cyclical squeezes in risk assets, we are undeniably in a stagflationary regime.
The global financial system is in a liquidity drought and inflation is the relentless sun. The dollar is the patch of shade in where weary travelers sit to rest. Though the traveler’s thirst still grows while sitting in the shade of the dollar from guaranteed negative real returns, it’s better than no shade at all.
Occasionally, storms form, bringing rain to the desert in the form of short squeezes and bear market rallies. Some daring market participants use this opportunity to leave the shade in the search of an oasis while the sun is not shining.
However, the storms never last long enough and those caught without shade when the sun returns die of thirst.
Stay mindful of the market regime and wear your sunscreen.
Bitcoin
Bitcoin has been holding the 20k level quite admirably despite the precipitous fall in US equities.
Bitcoin/S&P has been pretty rangebound in the past few months, dipping to new lows earlier last week after Jackson hole before recovering. Many market pundits expect one more big break down between BTC and S&P during the year.
Bitcoin dominance is nearing YTD lows as the Ethereum Merge narrative continues to dominate. This is unlike previous cycles that saw BTC dominance increase in bear markets.
BTC volatility markets still show a healthy premium on implied vs. realized volatility, which has been quite good for vol sellers in the past month.
Ethereum
Volatile week for ETH as the Merge on Sep 15 nears. This primer by Coin Metrics was a great read on the merge.
The merge has been a strong narrative for ETH price action, with simulations showing that ETH will go from inflationary to deflationary if PoS is activated, replacing the rewards to miners with a smaller amount of rewards to validators akin to a triple Bitcoin halvening.
Complex blockchain upgrades are not without risks, however, as markets are still pricing in a non-negligible chance of failure.
Staked ETH is still trading at a 3% discount to ETH
ETHW, a proposed fork of ETH created by miners after the merge has settled in a trading range at 0.03 ETH.
Volatility markets are still quite optimistic on ETH relative to BTC leading up to the merge looking at 25d skew.
The ETH merge has been the crypto community’s strongest narrative amid the deterioration of the global macro environment. Fingers are crossed for a successful Merge!
Solana
Solana price action has been quite rough following the reversal in late August, clinging to the SR level at 31.
Volatility markets are expecting more downside volatility in the weeks to come given the lack of a strong narrative for SOL.
Volt Performance
Friktion earned $130,534 last week for its depositors.
Volt #04 continues to do quite well in this market environment as demands for shorts pays off the short basis position.
Interested in contributing to the Friktion quantitative research and strategy effort? Join one of our Taskforces and let’s build the future of finance together.
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