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Last week's markets seemed stagnant amidst a mix of negative US leading economic indicators yet stronger-than-anticipated services PMI. However, this all changed with Monday’s First Republic Bank earnings report which spooked investors and sent the stock plummeting. The bank reported a $40B loss in deposits, which is not the end of the world, but clearly not a bounce back like many had hoped.
Bonds were the only major asset class that was up relative to mid-April.
The laggard this time was BTC. Bitcoin experienced a 10% pullback, which may not be unreasonable considering its volatility and previous month's stellar performance. What’s hard to see on this chart however, is that as stock markets collapsed on Tuesday, Bitcoin and gold regained traction in late afternoon trading. If you believe that this crisis is not over, then it will still have some room to run.
Regulatory rumblings have also contributed to the selloff in crypto in the last few weeks. As the saga of various bankrupt crypto companies continues to unfold, it becomes increasingly evident that regulators are seeking to impose tighter restrictions on the industry. The SEC sought to broaden the definition of an “exchange”, potentially impacting a wide range of crypto entities, from DEXs to generic smart contracts.
Luckily, this has not been a one way street and there has been strong pushback from within the SEC, with SEC Commissioner Hester Peirce openly criticizing the measures in an open letter, stating that proposed regulations are a solution looking for a problem with the goal of ending innovation in the crypto space.
What surprised the industry however, was the congressional hearing on oversight of the SEC.
You have to watch it to believe it here, and here. The main rhetoric from the SEC is that the securities laws are clear. Ok, then is Ethereum, the second largest crypto by market cap, a security? No comment.
How can the law be so clear yet the SEC is unable to have a clear determination on a project that encompasses a huge swath of the ecosystem? Similar objections have been raised by the SEC in the case of Binance.us’ proposed acquisition of Voyager assets. The judge questioned the SEC's objections pointedly saying that the SEC was unable to identify whether the proposed transaction actually breached any laws.
What is at stake is whether the USA will have a seat at the table on the biggest financial innovation since the invention of securities themselves. (Clearly I’m slightly biased here). While the US continued on its strategy of enforcement by litigation, Europe has formally ratified harmonized regulation on Markets in Crypto Assets (MiCA).
While there will be a period for each country to implement its interpretation of MiCA, it is a huge step forward to bringing clear regulation on what can be done for specific parts of the crypto ecosystem, allowing businesses to move forward with certainty.
Meanwhile, the ecosystem has not been sitting still…
While congress has been talking in hypotheticals about innovation leaving the US, Coinbase has been literally doing just that. Coinbase received a license to operate in Bermuda, and will launch an offshore exchange that can trade derivatives.
Not to be outdone, Gemini also announced they will set up a non-US derivatives exchange.
This is a potentially lucrative source of revenue as margins on leveraged products such as perpetual futures are significantly higher than spot trading.
Furthermore, on the regulatory front, Coinbase just filed a lawsuit against the SEC. It asks the SEC to provide a definitive answer to its request from July 2022 for tailored crypto regulation. This sets up a potential battle that could potentially end the stalemate and put the US on a path to clear regulation.
So the tide is finally turning in crypto, is this the last stand or is this the counteroffensive? Time will tell. Meanwhile, there is a bigger banking crisis to worry about.
As a result of the bank not answering questions during the earnings call, investors assumed the worst, which is that it is not only a big problem, but a systemic one.
I was a little bit premature in calling for a pause in rate hikes last week when implied probabilities were around 70%, but they have round tripped going as high as 90% to dropping precipitously to around 75% on Tuesday with a week to go before the FOMC meeting. I think we have a decent chance of getting closer to 50/50 odds as the week progresses.
As I outlined last month, most of the malaise comes from providing unlimited liquidity to banks that are structurally solvent but underwater on their net interest margin. They will bleed slowly. It is a slightly better problem than all banks blowing up at once, if you can make everyone forget it’s an issue.
On the back of this, safe haven assets such as gold, bonds, and crypto have seen a resurgence with gold breaking above the critical $2000/oz level. The stakes are high for the Fed to get their next FOMC hike right.
Market participants have been warning of the impending collapse in economic activity as well as the Fed’s fixation on unemployment and wage metrics which are by far one of the most lagging indicators of economic activity. If the Fed got the inflation spike wrong in early 2021, they are making those same mistakes now by choking the economy to make sure it will be extra dead before they pause.
If you look at this chart, there’s no ambiguity that goods inflation is no more. Housing has also flatlined.
And rents are also coming down for the first time in 36 months.
We are also in a banking crisis where banks are facing a balance sheet recession essentially stopping lending in its tracks.
By the time we finally see bad numbers from the employment market, I’m afraid it’s going to be too late.
For those investors concerned about the market, the biggest question is what will happen first:
One thing is clear however, the Fed and Treasury have a track record of strong action, but require a bona fide fire before they will want to suit up. That could be 2 weeks, or that could be 2 quarters. This is further complicated by the debt ceiling which is very unfortunately timed to have a potential X-date right around when things should fall over in June. A tail scenario might see the US temporarily default, or the Treasury have issues providing extraordinary measures to stabilize the banking system, or both.
Probably not a bad bet to be long volatility for the next few weeks. Let’s see how the FOMC fireworks play out next week!