Merry Christmas and Happy New Year: TBL Weekly #123

and

Dec 21, 2024

Good morning Readers!

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As we enter the last weekend before Christmas, the Fed made sure its 2024 goodbye was a memorable one. For starters, risk markets sold off during Fed day as a result of its newest—and more hawkish—dot plot. The S&P 500 retraced back to 5,840 points, entirely wiping out post-election gains. Similarly, bitcoin pulled back 15% ($16,000) from its $108,000 highs earlier in the week—a drop in the ocean of historical bitcoin sell-offs. So, in the last 2024 edition of the TBL Weekly, as well as our last free publication, we will take it back to our basic framework to showcase exactly what TBL Pro is all about. We will look at:

TBL Liquidity
Our next TBL Liquidity addition: the dollar.
China
US Rates
Bitcoin

Without further ado, grab a coffee, and let’s unpack our TBL Weekly #123.

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Weekly Analysis

TBL LIQUIDITY

Let’s start off by explaining our basic TBL Liquidity framework. The three main components consist of (1) global banking assets, (2) US Treasury prices, and (3) US Treasury volatility. Increases in global banking assets give way to credit expansion worldwide, which, in turn, impacts risk assets like bitcoin. Treasury prices also impact (though not dictate) the path on which risk assets walk by making the future more or less expensive. Lastly, banks lend to one another via secured overnight markets by using Treasuries as the ultimate collateral; thus, increases in the volatility of the underlying collateral for these loans has a dramatic impact on credit expansion. Combine these three things and you get a pretty potent TBL Liquidity measure that reaches a 54% correlation with the S&P 500.

As we close out the year, we decided to take one last look at how these two have moved throughout 2024, and we found an interesting pattern:

Throughout the year, whenever our TBL Liquidity measure reached a level of approximately $70 trillion, the S&P 500 reached previous all-time highs, or made new ones—as highlighted by the red circles on both panes. Also, notice how almost every time we reach that $70 trillion mark, the S&P 500 pulls back or consolidates. It looks like that same pattern is repeating this month. Interestingly, this latest downturn in TBL Liquidity is not due to some abnormal bond volatility; in fact, bond volatility is at pretty normal historical levels:

This latest downturn in risk assets has to do with our next addition to our TBL Liquidity measure.

US DOLLAR

A strong dollar is not good for global liquidity on net, which is consequently not good for risk assets. Generally speaking, countries don’t want their currencies to weaken too much against the dollar because it raises the price of energy and any other imports, so whenever the dollar strengthens, foreign central banks tighten policy, raise rates to keep capital in local currency, which decreases liquidity. Moreover, a stronger dollar also means that dollar borrowers face a tougher time affording interest payments, which decreases dollar credit demand. Looking at the following chart, this relationship has played out quite well over the past 3 years. When the dollar, inverted on the chart, strengthens (green line goes down), stocks feel the pressure:

As 2022 started, the dollar strengthened, which paired with an overall decrease in the S&P 500. Then, during 2023’s stock bull-run, the dollar weakened. Lastly, 2024 has seen an interesting pattern. Overall, the dollar has had a positive co-movement with risk assets, especially after the election. However, this week, we finally regressed back to the mean pattern: the dollar reached levels not seen since 2022, and equities plummeted.

CHINA

Now, given that the DXY index does not take into account the Chinese yuan, it would be remiss of us as analysts to not look at this couple:

The devaluation of the Chinese yuan is tempting all-time weakest…yet again. What’s even more interesting is where the Chinese 10-year yield lies, somewhere at the bottom of Niagara Falls. A stunning collapse:

The yield has now pushed way beyond its 2002 lows. Falling yields reflect the incredibly depressed outlook on future growth in the Chinese economy with Donald Trump’s infamous tariffs returning to the spotlight. So, as the Chinese government allegedly prepares for some massive liquidity injections, Asian investors must choose assets to hedge away this risk, or participate in outright capital flight, with bitcoin appearing to be involved in the trade:

We regressed bitcoin onto the Chinese yuan and found a 55% correlation between the two. How do we interpret this? Well, as the yuan devalues, Chinese investors look for safety in assets that are inherently protected from capital controls. Thus, bitcoin rises when the yuan falls, and vice-versa. Friday’s pullback on bitcoin was paired with a strengthening CNY.

US RATES

Let’s discuss the US Treasury component of TBL Liquidity. This week, we saw a very similar reaction by US rates to the one experienced during the Fed’s 50-basis-points cut in September. Just look at the chart below, which shows the first and third rate cuts of this cycle surrounded by moves steeper in the curve:

The cause of each move was an increase in 10-year yields, each time on the expectation that growth and inflation will be supported. Said another way, if the Fed is cutting rates with inflation still well above the supposed 2% target, it means that it isn’t really serious about getting it there. At least, this is what investors appear to be expressing.

We should also be aware of the recession parallels: re-steepening events are usually recessions as rate cuts happen during recessions:

Today, however, rate cuts are happening without a recession, causing many who doubted the soft landing to eat their words. We canceled our recession watch days after the election, largely because the expected labor slowdown wasn’t impacting wages at all, a housing sector resilient to 7% mortgage rates, deregulation expectations, an AI boom we never could have fathomed, and the shocking disintegration of economies outside of the US. We are aware a global recession could very well drag the US down, but we can’t see negative growth on the horizon, despite seeing a path to lower yields from here, some disinflation in 2025, challenged pockets of the labor force, and a higher unemployment rate which fits with our AI narrative.

In this environment, a re-steepening could actually be healthy for markets after such a long time of the curve being inverted. The average yield across the curve has now surpassed the Fed funds rate after this month’s cut:

This means that carrying Treasuries is no longer more expensive than funding them, which could create some price stability, which means less bond volatility, which means less hiccups in funding markets, which means more liquidity.

The fact that the Fed decreased the overnight repo rate by an additional five basis points beyond the 25 basis point range cut tells us that it cares about these hiccups. FOMC memebers want to make sure that money leaves the reverse repo facility in search of better returns, which provides liquidity for the system as we approach year-end. So far, their plan has worked; the facility is now sub-$100B for the first time since early 2021:

BITCOIN

Bitcoin had a volatile week, with a 15% drawdown supported under $93,000 as of this writing. We love the momentum reset, large wick and support around a late-November price area, and now we’ll really look for bitcoin buyers to hold their support to continue this bull market. A breakdown below $88,000-$93,000 would open up the entire election move. This area will be a behaviorally important one—we would like to see bitcoin stay above $88,000 or so to maintain momentum. Bitcoin followed TBL Liquidity lower as Treasury yields rose materially:

Lastly, looking at the most important on-chain indicator for bitcoin, MVRV is at relatively healthy levels within this bull run. There is room to run, and our price projections for the late stage of this particular wave are coming more clearly into view. Nice to see $1 million appear on the y-axis:

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Economic events next week

In case you missed it: TBL on YouTube

Forget Tax Cuts: The Strategic Bitcoin Reserve Is America’s First Move

In this episode, Nik Bhatia and Matt Dines explore the seismic shifts in the global economy, focusing on China’s deflationary crisis, America’s industrial resurgence, and Bitcoin’s accelerating role in financial markets. They examine China’s collapsing sovereign bond yields, aging demographics, and reliance on exports, signaling deep economic challenges and policy uncertainty. Shifting to the U.S., Nik and Matt analyze the rise of industrial policy, reshoring momentum, and the impact of a strong dollar in navigating inflation and growth. They discuss the risks of tax cuts in a post-2024 political landscape and the transformative potential of the Bitcoin Strategic Reserve Act as a generational policy shift. Closing with Bitcoin’s emergence as a major player in corporate debt markets, led by MicroStrategy’s use of convertible bonds, Nik and Matt paint a picture of a world where Bitcoin is no longer on the sidelines but at the center of the global economic realignment.

Here are some of the key insights:

China’s Sovereign Debt Collapse: Chinese bond yields have fallen to record lows, signaling deflationary pressures tied to internal credit issues and slowing economic growth. The depreciation of the yuan remains a key risk.
Export Challenges and Monetary Policy Shifts: Declining external demand from the U.S. and Europe, paired with aging demographics, forces China to adopt “moderately loose” monetary policies and increased central bank purchases of debt.
U.S. Reshoring Progress: The TSMC semiconductor plant in Arizona highlights U.S. efforts to restore industrial capacity. Despite cultural and logistical hurdles, the project represents a successful example of attracting high-value investment.
Strong Dollar Dynamics: The robust dollar supports U.S. industrial expansion by facilitating resource imports while placing strain on global economies reliant on weaker currencies.
Bitcoin-Driven Convertible Bond Growth: Bitcoin-related issuers, such as MicroStrategy and Coinbase, dominate the convertible bond market, now ranking as the second-largest sector by market value for 2024.
Potential Bitcoin Strategic Reserve: A proposed U.S. Bitcoin Strategic Reserve Act could solidify Bitcoin’s role in national policy, offering a groundbreaking shift in financial strategy.
Trump 2.0 Economic Strategy: The new administration is expected to double down on reshoring and industrial policy, navigating challenges such as bond market stability and managing fiscal expansion risks.

Dollar Dominates as Global Markets Surrender to U.S. Growth, More Fed Cuts Likely

In this episode, Nik Bhatia is joined by George Goncalves, head of US strategy at MUFG, to deliver a timely global macro update following the Federal Reserve’s latest rate cut and hawkish signals. They explore how the Fed’s shift marks a potential end to the easing cycle, the implications for a steepening yield curve, and the unprecedented strength of the U.S. dollar as global currencies falter. George provides insights into the mechanics of the Fed’s balance sheet strategy, the shrinking reverse repo program, and the potential timeline for quantitative tightening. Together, they analyze how these developments intersect with Trump’s incoming administration, touching on tax cuts, industrial policy, and fiscal reform. Closing with a discussion on liquidity, credit markets, and the evolving role of private sector money creation, they chart the intersection of monetary policy and global economic dominance heading into 2025.

Here are some of the key insights:

Fed’s Rate Cut and QT Adjustments: The Fed cut rates by 25 basis points, bringing the target range to 4.25%-4.5%. Additionally, the RRP rate was adjusted to align with the lower bound of the Fed funds range, signaling potential limits to further balance sheet reductions.
Market Reaction and Hawkish Messaging: Despite the rate cut, Fed Chair Jerome Powell delivered hawkish guidance, reducing the expected number of 2025 rate cuts to two. Equities saw one of the largest Fed-day declines, and Treasury yields experienced significant volatility.
Liquidity and QT Challenges: The Fed’s quantitative tightening has largely reduced the RRP balance, now close to exhaustion. Bank reserves are also shrinking, indicating that QT may need to end by early 2025 to prevent excessive liquidity drainage.
Trump 2.0 Economic Landscape: The incoming administration inherits elevated equity valuations, constrained fiscal flexibility, and significant debt servicing costs. The high starting points for market valuations and fiscal debt complicate policy execution.
Wealth Effect and Economic Sensitivity: The U.S. economy is heavily reliant on government spending and the wealth effect from high stock market valuations. Any disruption to these drivers risks a significant slowdown in economic growth.
Bank Lending and Credit Creation: Non-financial institution lending has been a key growth area, but overall loan growth remains below the 5% threshold needed for sustained economic activity. A steep yield curve and lower rates are essential to encourage private credit creation.
Bitcoin’s Divergence from Liquidity Trends: Historically tied to Fed liquidity, Bitcoin decoupled in 2024, likely driven by private sector flows, including funding through convertible bonds and increased adoption of Bitcoin-focused financial instruments.
Global Policy Divergences: Japan’s efforts to raise rates contrast with the Fed’s slower pace of cuts, highlighting global monetary policy divergence. This divergence adds risks to carry trades and global liquidity stability.
Interest Burden and Fiscal Drag: U.S. interest expenses now account for nearly half of the fiscal deficit, severely limiting fiscal flexibility without further rate cuts or aggressive policy changes.

Bitcoin Is Trump’s Scorecard, Strategic Reserve LIKELY

In this episode, Nik Bhatia and Craig Shapiro explore the ripple effects of Federal Reserve policies, market movements, and the strength of the U.S. dollar under Trump’s pro-Bitcoin administration. They unpack how rising yields, persistent inflation, and tightening financial conditions are reshaping risk assets like Bitcoin, while the dollar acts as a “wrecking ball” across global markets. With insights from the Bear Traps Report, they highlight Bitcoin’s role as a symbolic “scorecard” for Trump’s economic agenda and discuss its potential as a national asset under a populist-driven strategy. Wrapping up, they assess the geopolitical landscape and the future of financial markets, exploring how these forces could shape Bitcoin’s trajectory in a volatile economic environment.

Here are some of the key insights:

Bond Yields and Fed Rate Cuts: Despite the Fed initiating a cutting cycle with three rate reductions in 2024, yields have risen sharply. The bond market reflects skepticism about the Fed’s ability to bring inflation down to its 2% target within a reasonable timeline, with term premiums increasing and inflation expectations persisting into 2027.
Hawkish Messaging from the Fed: The Fed’s December meeting featured a "hawkish cut," reducing the number of expected future rate cuts for 2025 and 2026. The bond market remains unconvinced, as inflation risks and uncertainties remain elevated.
Market Compensation and Yield Levels: Investors demand higher yields to compensate for inflation risks. Craig suggests that if the 10-year yield reaches 5% or higher, it could trigger greater equity market and risk asset volatility.
Dollar Strength and Global Implications: A strong dollar driven by U.S. growth and yield differentials exerts pressure on global markets, particularly emerging markets, reminiscent of the 2013 taper tantrum. Protectionist policies under the Trump administration may further strengthen the dollar, creating challenges for non-dollar economies.
Bitcoin as a Strategic Asset: Bitcoin's role is evolving under a pro-Bitcoin Trump administration. Craig highlights that Bitcoin could become a scorecard for the administration, diverging from other risk assets during a broader market selloff.
Equity Valuations and Risk Asset Concerns: Elevated equity valuations and speculative froth in crypto markets suggest the potential for corrections. Craig advises caution, favoring cash or short-term instruments like three-month Treasury bills over long-term bonds or high-risk equities.
Wealth Effect and Inflation Feedback Loop: Higher yields and a strong dollar may tighten financial conditions, cooling the wealth effect and ultimately helping the Fed control inflation. However, geopolitical and fiscal uncertainties remain significant variables.