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Global Macro Update - 9/17/2021
US dollar strength and Chinese defaults
I wrote a guest post last night for my friend and superstar on-chain analyst Will Clemente; I didn’t want you all to miss it, so I’m including it below. Make sure to check out Will’s newsletter, a deep study of bitcoin blockchain and exchange data. I’ll be honest: most of Will’s analysis still goes above my head, and I’m in the midst of an on-chain learning process these days (more to come on this next week). For now, check out his work to familiarize yourself with this vital new study. Please also subscribe to The Bitcoin Layer to receive all updates from me straight to your inbox!
Global Macro Update - 9/17/2021
Over the years, Bitcoin has battled a narrative of equity-market correlation. Rightfully so, as the pandemic crash of March 2020 showed: Bitcoin can definitely act like a risk-on/risk-off asset. On the currency side, the Bitcoin price has also periodically correlated with the Chinese yuan due to capital fleeing the country. However, it’s most fair to say that Bitcoin is its own beast and doesn’t derive correlation from other asset classes. As a commodity, it has its own features, characteristics, and internals that drive underlying valuation. Nevertheless, Bitcoin responds to the global macro environment and is itself a product of it, and therefore we must watch themes that contribute to the underlying thesis of a long Bitcoin position, namely themes of financial market fragility. Today, we’ll discuss the dollar and China.
The global dollar system is on thin ice and in constant need of liquidity creation by the Federal Reserve, but the US dollar still maintains a stranglehold over all other global currencies. When USD strengthens, it’s a sign that investors around the globe are fearful of economic and financial market weakness. Here’s the Bloomberg Dollar Spot Index (BBDXY) over the past couple of years.
In March 2020, during the height of the pandemic-induced liquidity crisis, notice how USD screamed higher as fear took over the markets. After that jolt, a steady decline in the dollar resulted from the Fed’s guarantee of infinite Quantitative Easing. When the Fed eases monetary policy, markets breathe a sigh of relief, sell USD, and buy riskier assets denominated in other currencies.
For the past several months, however, USD is forming a base and looks to be forming a modest uptrend. The dollar is responding in part to the Fed threatening a “taper” of QE, which is another way to say “less heroin to the banking system’s vein than in previous months.” This is something to watch closely, because a USD rally would be the symptom (not the cause) of global economic weakness, however relative it might be. How Bitcoin will react to small moves in the dollar is anybody’s guess, but another round of asset price declines always would back the opportunity for Bitcoin to exhibit traits of being a safe-haven asset, instead of a risk-asset. A second-order effect of dollar strength is that global economic weakness often triggers bailouts, which undermines confidence in the traditional financial system, further emboldening the bull case for Bitcoin. Bottom line here: net dollar strength is a net tightening of financial conditions, something to watch closely.
Speaking of bailouts, Chinese property giant Evergrande is on the brink of default. Those immediately affected include suppliers demanding payment, employees potentially receiving future property instead of money market deposits, homebuyers facing unfinished property, bondholders, and the list goes on. While still too early to tell how widely this contagion will spread, calls for emergency measures from China’s leadership grow louder every day. Here’s China’s high-yield bond index over the past several years.
Yields are right back up against the March 2020 crisis highs as bondholders are selling positions in risky Chinese corporates. This shows us that contagion is already spreading beyond Evergrande, but there’s no evidence yet that this selling is going to spill over to US fixed-income markets. In China, however, things might get interesting. According to Bloomberg, “Some banks in China appear to be hoarding yuan at the highest cost in almost four years, a sign they may be preparing for what a Mizuho Financial Group Inc. strategist called a ‘liquidity squeeze in crisis mode.’” Evergrande is expected to miss its first interest payment on September 20. How quickly will Chinese authorities intervene?