Inversions Everywhere: TBL Weekly #21
Recapping the action in bitcoin and macro.
Welcome to TBL Weekly #21—here are your highlights!
Our monitor for the week ending Saturday, November 19th, 2022:
With bitcoin trading at a large discount to realized value and Electricity Hash Value, one can only hope for the dry powder and patience to allocate and wait for the next bull market. But with crypto industry bankruptcy proceedings at the front of market participants’ minds, it is unlikely that new bulls rage onto the scene without a catalyst.
Where will it come from? One place might be the Federal Reserve. That’s because with a drastically slowing global economy and severe yield-curve inversions, the prospect of persistent inflation seems to be fading. In fact, with shipping costs plummeting, we can start to rest easier in our thesis that this year’s inflation was mostly caused by supply chain disruptions:
While we understand the long-term implications of monetary easing, the reality of depressed bitcoin prices during this year’s scorching inflation can be largely attributed to monetary tightening. That tightening has also impacted the economy at large, as is evidenced by aforementioned shipping costs, a dismal US housing market, falling crude oil prices, and Japanese and European economic contractions. We don’t want to just gloss over falling energy costs—amidst all the fear of Putin-induced energy crisis and a terribly low US diesel stock, the oil price is objectively collapsing. The main driver, in our opinion, is global economic contraction. Why is FedEx laying off people ahead of the holiday season?
This has all resulted in some of the deepest and loudest yield-curve inversions the rates market has ever seen.
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Starting with 2s10s, a curve which has reached negative 70 basis points, we conclude that a deep contraction of the US economy is before us, one that is sure to be followed with rate cuts:
And a zoomed out look, with yield-curve inversions (falling below zero) leading a recession (marked by the red shaded areas) with 100% reliability. That’s right, 2s10s going negative signals a recession every time—sometimes within a few months, and other times up to two years after:
That’s right, rate cuts are coming. You have seen and heard us use the word “hikes” constantly this year, but 2023 is the year of the cut. We remain out of consensus amongst analysts, but we do receive some sympathy from money market curves (read Eurodollar futures). One curve we are watching closely is the US Treasury 10-year yield versus Fed Funds. Ian Lyngen, head of rates at BMO Capital Markets, had this to say about 10s and Fed Funds inverting (EFFR here stands for effective Fed Funds rate):
"The milestone of 10-year yields moving below EFFR has been achieved - a notable development insofar as history tends to see EFFR/10s remain positive until the final hike of a cycle has been delivered. Admittedly, it is still too soon to call a deeper, sustained subzero EFFR/10s environment an inevitability, but with at least two (if not three) more hikes to be realized, the move is nonetheless noteworthy."
As the bid for duration continues as growth expectations continue falling while policy rate expectations remain elevated, we could see triple-digit inversion on 2s10s—something not seen since the late ‘70s and early ‘80s, and a loud signal to the Fed that it has achieved significantly restrictive territory from 10sFFs:
What does it mean for capital markets when the yield on 10s falls below the policy rate? For starters, any bank that is holding 10s and financing them through the repo market is likely in a negative carry position. This means that the rate on the money borrowed is higher than the yield on the security itself. It makes holding any fixed-income instrument on leverage punitive to the balance sheet—banks will not take this situation with a smile for long. This is what we mean by the rates market leads the Fed, because eventually the Fed has to look at the reality of capital markets instead of its own inflation models.
While many are calling for structurally higher inflation for the coming years, as well as higher-for-longer policy rates (including some of our recent guests on The Bitcoin Layer’s YouTube channel and syndicated podcast), we definitively take the other side. The more the Fed continues on its tightening path, assuming another December 50 basis point hike and potentially more in Q1 2023, the more certain we are that swift cutting of the policy rate is right behind.
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Now, here are your quick links to all of the TBL content for the week:
The fallout of the FTX deleveraging is upon us, and until it has fully run its course, bitcoin’s price future remains in question. Industry players become forced sellers, and the selling is cascading throughout connected counterparties—bitcoin is unfortunately caught in the balance sheet crossfire until the bad leverage is purged from the system. As the global growth slowdown is met with easing talk by Fed speakers, the FTX/Alameda contagion is sweeping through the ecosystem and snatching heads. This post gets into the nitty gritty of the bitcoin market’s inner workings:
Joe spoke with James Lavish, a hedge fund manager, CFA charterholder,
co-founder of Looking Glass Education, and the author of the popular
The Informationist Newsletter on Substack—go subscribe! In this episode, James discusses the pivotal books which lead him on his journey to bitcoin, the issue of central banks becoming the marginal buyer of their own sovereign debt and currencies, the United States debt problem, and the bitcoin of it all:
The era of hyper-pontification and wordsmithing is coming to an end. As the casino of Ponzi schemes vaporizes billions of investor wealth yet again, self-flatulating and vacuous words like blockchain, crypto, web3, and DeFi are being widely understood for what they are—abject scams. While we fully sympathize with the spirit of decentralized finance, trying to find it outside of the bitcoin ecosystem is presently impossible—the word “DeFi” in and of itself has been indelibly tainted by rampant centralization, censorship, and outright fraud.
As many have posited, the solution for the FTX explosion (centralized finance) may have been more DeFi, or decentralized finance, but no present or future protocol can or will achieve resilient decentralization at scale.
Thankfully, bitcoin already has achieved decentralization—and its continued growth and development of native financial plumbing indicate that bitcoin has a future as both a base layer asset and the foundation for real decentralized finance:
With Elizabeth Holmes now sentenced to 11 years in prison, are you taking the over or under for Sam Bankman-Fried? Have a great weekend everybody!
The Bitcoin Layer does not provide investment advice.
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