What happened to the Super Cycle?

As the vicious cryptocurrency bear market we are all living through rages on, it’s difficult to remember how vastly different conditions were in the recent past. Throughout 2020 and 2021, we gradually saw even the biggest bears turn bullish on the blockchain space. Calls for “100k Bitcoin” and even “1m Bitcoin!!!” were seen all over social media. As someone who uses technical analysis frequently, I saw the most heinous chart forecasting crimes attempting to justify these outlandish price forecasts.

It seemed everyone was getting rich in crypto. Lamborghinis and Rolex’s became the norm, people were trading pictures of Rocks and Monkeys for 6, 7 even 8 figures and the world was filled with people quitting their jobs to become full-time traders. Even my mum Whatsapped me to ask, “Should I buy Bitcoin?”!!

Then, as it always does, it all came crashing down. So, what actually happened? The short answer is the Fed.

First off, it is important that we are on the same page in relation to the Fed’s mission:

“

• Conducting the nation’s monetary policy by influencing money and credit conditions in the economy in pursuit of full employment and stable prices.
• Supervising and regulating banks and other important financial institutions to ensure the safety and soundness of the nation’s banking and financial system and to protect the credit rights of consumers.
• Maintaining the stability of the financial system and containing systemic risk that may arise in financial markets.
• Providing certain financial services to the U.S. government, U.S. financial institutions, and foreign official institutions, and playing a major role in operating and overseeing the nation’s payments systems.

“

There are many different views on what caused the Fed to change its stance away from loose monetary conditions. The consensus view seems to be that it was due to rising inflation. Some also cite that the Fed may have seen the necessity to unwind the highly leveraged positions which had dangerously driven the market. In contrast, others point to the individual cataclysms we have seen within the crypto sector: with projects like Terra and Celsius imploding.

Personally, while those are absolutely contributing factors in the correction, I believe the root cause is elsewhere.

Since 2008, we have seen pretty consistent Quantitative Easing (QE), and the relaxing of market restrictions on capital flows. This created a sort of ‘nirvana’ in most markets, allowing for the most incredible bull run in a generation. Once COVID moved to a Pandemic level event, markets reacted extremely aggressively, with the NYSE seeing limit down market closures multiple times within a few days. This was unheard of.

The response? In a word… Unbelievable.

The money printing measures introduced not just by the Fed, but all Central Banks around the world as a direct response to the pandemic, created the most aggressive buying campaign the markets have ever seen, ultimately resulting in the Dow Jones Industrial Average rallying ~100% in 2022, from its lows in 2020.

(Source: Tradingview)

This rally wasn’t just in US Equities however, it was everywhere. Housing, Commodities, Crypto, anywhere you could park your money in fact saw great returns as this extra liquidity washed through the system. .

For Crypto, we saw a wall of capital flow in, ultimately resulting in a 2,539% total gain:

(Source: Tradingview)

Then everything changed.

We saw Crypto go through one of its most aggressive corrections ever, with the Total MCAP retreating ~75%. Many of the raft of newer market participants attracted to the crypto sector during the two-year bull run lost significant amounts of money and ran for the hills. running for the hills.

(Source: Tradingview)

I want to look at what has fundamentally changed.

I believe what shifted sentiment so significantly is the marked change in central Bank Policies (specifically the Fed), given their policies were the root cause of much of the incredible performance we saw during the COVID period.

So firstly, let’s take a look at a simple graph which looks at M1 Money Supply, vs BTC.

You can see on this chart that I have separated it into 2 clear periods:

1. The Unlimited QE COVID Response period
2. QT Announced

It was during the Unlimited QE COVID Response period that we saw the unbelievable gains for the BTC and the wider crypto market. You can see how the M1 Supply bled into the market as investors looked for locations to park their new cash.

However, you can see the impact of the switch of stance by the Fed, and the mere suggestion of Quantitative Tightening (QT). It was in November 2021, when Jerome Powell announced a cliff for the QE program, and that we would start to see considerable tightening, which has finally begun through June 2022.

You cannot look at QE and QT programs alone, however.

The chart below shows BTC vs inflation vs the Fed Funds Rate & Forward Curve.

Similarly to the M1 Supply chart, we see Bitcoin reacting extremely positively to the initial COVID response. When the Fed brought rates to 0, in conjunction with the QE program, Bitcoin began its parabolic move.

However, on announcements of both QT and the rate hike cycle incoming, investors switched to a risk-off stance, pulling Bitcoin and the wider market down. Some interesting data points we can pull from this chart:

• BTC enjoys an environment where rates are low and QE is considerable.
• BTC’s correlation inverts during a rate hike cycle
• BTC’s correlation inverts on the announcement of a QT program

Now that we understand these correlations, we can make the following statement:

“Bitcoin and the wider crypto market flourishes in a broad, risk-on environment where rates are low, and the threats of Quantitative Tightening and Rate Hikes are low.”

Looking forward now, the forward curve for rate expectations is shown below:

At present, the markets are pricing a high likelihood of rates hitting >4% into 2024, and the most recent dot plot does not suggest any appetite for cuts in 2024:

This is important because we have shown that in a rate hike environment, BTC does not perform particularly well.

However, there was a very interesting reaction to the July hike, where the Fed raised rates by 75bps, which was in line with ‘dovish’ expectations, and signalled a potential softening in stance. The market reaction was favourable, as the fed did in fact raise as expected. This was unfortunately followed by a fairly aggressive hike in September of another 75bps, and a signal of another 100/125 by end of 2022. So even though no one is suggesting rate hikes are over, the simple prospect of the end of the rate rise cycle drawing closer led to a meaningful rally in all risk assets including crypto.

So, looking ahead at rate expectations in the futures market, investors are pricing in an end to rate hikes early next year. Every piece of data will be used to assess whether this slightly more favourable outlook is likely to come to pass. The key factor in market moves is as we know how outcomes measure against expectations far more than what the actual outcome is in nominal terms. For example, the market’s pricing of a 50 to 75bps hike in September was correct, and the BTC price remained stable. Much like the response to the pre-emptive announcement of hikes and QT, any Fed change in stance may have a dramatic impact on crypto prices.

For me, I am keeping a keen eye on the data that may drive the Fed’s decisions on both the QT program, as well as on rates. The Fed has no choice but to be ‘data led’ so we can get a reasonably useful indication from data releases on inflation and especially the labour market in attempting to assess whether the Fed’s approach may become more accommodating.

Monitoring the Consumer Price Index and the Employment Cost Index is critical in trying to determine how far the Fed will go, and with that, we can actually forecast with some accuracy as to whether the decisions will be more hawkish, or more dovish than market expectations.

As we move into the Autumn and Winter months, with global headwinds as prevalent as ever, I expect to see some relief rallies as the markets begin to once again price through the coming pain. Although Fed Chairman Jerome Powell has warned against this, it is in the market’s nature to be 18 months forward-looking, and price for hope rather than despair.

Moose is Co-Founder & Analyst at Dragonfly Asset Management.

DISCLAIMER: This content is for EDUCATIONAL AND ENTERTAINMENT PURPOSES ONLY and nothing contained in this blog should be construed as investment advice. Any reference to an investment’s past or potential performance is not, and should not be construed as, a recommendation or as a guarantee of any specific outcome or profit.