Black Swan: Central Banking and Market Collapse
For reasons you all know, stock market indexes around the world have plunged between 25%-40% at the time of writing, after being traded at close to or at all-time highs only two weeks earlier. The news of the spreading pandemic acted as the black swan that catalyzed the global market meltdown. From the peak of the market, the Dow dropped 20% in just 20 days, the fastest 20% drop in American economic history.
Interestingly, stocks were going through the roof (in a manner more familiar to the cryptocurrency markets) just before the economic scare. Since then, central banks around the world have reacted to this situation, lowering rates and injecting liquidity into financial markets. The Federal Reserve is now targeting a range of 0–0.25% for the Federal Funds Rate, a decrease of an additional 100 basis points (1%) since March 3, when the Fed first decreased rates as a response to coronavirus by 50 basis points.
Additionally, the Fed has injected $1.5 trillion into US repo markets in an attempt to increase liquidity and calm US markets. It is telling, however, that markets actually dropped in reaction to the decrease in rates, with the S&P tripping the circuit breaker at the opening of markets on Monday, 10/16, and ending over 12% down at the end of the day.
Across the world, central banks have largely followed the Fed’s actions. The Bank of Japan doubled its equity-buying program to $112 billion a year. The Bank of England cute rates by 50 basis points, and the European Central Bank increased asset purchases by €120 billion.
Whereas the Federal Reserve began normalizing its balance sheet in the latter half of 2017, it reversed course in September 2019 and began repo operations to help fix the federal funds market. Since then, with the additional injection of liquidity during the coronavirus situation, the Fed’s balance sheet has sharply increased in size, reaching its all-time high.
We believe this crisis may have revealed systemic risks in the traditional financial system and plan on writing more about this in a future blog post, so look out for that.
In the short run we’ve seen Bitcoin drop significantly in price alongside equities, as Bitcoin’s volatility has spiked alongside the S&P volatility. This recent drop has caused many in the crypto community to become disillusioned about the digital gold narrative, as speculators hoped that bitcoin and equities would be inversely correlated during scenarios like this. Some people have used the events of the last two weeks as a proof that Bitcoin is indeed a risk-on asset. However, it is easy to forget that during the GFC, gold first crashed in 2008, as speculators reduced risk, before retracing its crash by early 2009, and growing to all-time highs subsequently. If the pandemic crisis leads to a genuine crisis in banking liquidity, it could be a boon to Bitcoin if enough people believe in the digital gold narrative or find it useful as a financial tool external to the banking networks.
While central banks in this emergency take unprecedented steps to soften the blow of coronavirus, it remains to be seen in the following months how Bitcoin reacts to a deepening financial crisis and the corresponding inflationary monetary policy.
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