Competing Narratives

Tech stocks continued to party hard this past week🤘despite the negative dynamic of higher rates and a strengthening dollar amidst debt ceiling uncertainty. After starting the week on the back foot, catching “down” to the macro, a solid earnings beat from NVIDIA with quarterly guidance 50% above estimates drove a sharp turnaround to lead the Nasdaq 3.5% higher on the week (and over 5.5% higher from Wednesday’s close 😳.) NVIDIA is now approaching a $1trn market cap and is the poster child for the AI mania underpinning the tech sector and squeezing a market that has been caught short.

On the data front, PMI’s in Europe showed Manufacturing to be weakest since Covid lockdowns falling to a contractionary 44.6 in Europe, and 46.9 in the UK, dragging the respective composites down to 53.3 and 53.9. Services are holding everything up for now, but particularly in Europe, Germany’s deep manufacturing slowdown is a drag on the region's growth and reflects perhaps the broader global growth slowdown. Indeed, Germany has officially entered a recession, with GDP contracting 0.3% in Q1 (revised down from the initial estimate of 0%) following a 0.5% contraction in Q4.

Meanwhile, in the US, economic data surprised the upside and continues to display a resilience that defies the forward-looking indicators. Most disappointingly, the Fed’s preferred inflation indicator, the core PCE price index, ticked higher in April to 4.7%, up from 4.6% in March on a yearly basis. Personal spending also rose 0.8% in April, up from 0.1% and against expectations of a 0.4% increase. This complicates the Fed “pause,” with markets now pricing 65% probability of another hike in June, with a 100% probability of a 25bp hike by July. Friday’s employment report may be the deciding factor for a June hike or, as I still expect, a pause.

All of this combined to feed this recent dynamic of higher US yields and a stronger dollar, creating headwinds for Bitcoin and the broader crypto complex.

Debt-Ceiling Lift

Breaking news that the White House and Republican leaders have reached a deal to lift the debt ceiling and avoid default. The deal will suspend the $31.4trn debt ceiling until Jan 2025 (after the next election.) Details of the deal indicate that non-defense spending will be kept flat next year (with a 1% increase in 2025), although defense spending will be allowed to rise by 3%. Unspent covid funds, totaling $30bn, are to be returned. Elsewhere, some tinkering around social welfare but no major overhaul. Estimates suggest spending cuts will total a paltry 0.2% of GDP and total debt over that time frame to increase by over $4trn 🤯. The deal will pass to the house to be voted on Wednesday, with a rush to pass the legislation before the estimated 5th June X-date (when the US Treasury run out of money and risk default).

The knee-jerk response has seen crypto majors pop higher, with BTC and ETH reclaiming respective 28k and 1900 handles as I write. Immediately, the world’s largest economy and global reserve currency avoiding default can reasonably be deemed “risk positive” even if the chances of actual default remained close to zero. Of course, this was always just about politics.

This also continues to support the big picture bull narrative for Bitcoin. Namely, our fiat-based credit systems cannot survive and grow without ever more debt. The unsustainability of this debt means eventually, it gets “printed” away and will find itself sitting on the Fed balance sheet, which ultimately leads to the continued debasement of fiat currency.

The shorter term however, I remain cautious of the negative liquidity impact this will have on our markets. With the debt ceiling lift allowing the US Treasury to return to the debt markets, the issuance of this debt will be a significant liquidity drain, with the treasury looking to build the TGA back to 500bn by the end of June! There is, of course nuance with this. Issuing via T-bills will be more easily absorbed given the lower duration profile. It could also be off-set if the money parked at the Fed’s overnight Reverse Repo facility (RRP), which currently sits in excess of $2trn is teased out to earn higher yielding T-bills.

How US yields and the dollar react in the days/weeks ahead will also be significant. Both have moved decently higher in the past couple of weeks and formed this negative dynamic that has kept a lid on Bitcoin, which wasn’t allowed to join the tech stock party. Whilst markets have re-priced expectations for the Fed, concerns surrounding a potential debt default are significant drivers of those moves. If those moves prove to be a “buy the rumor, sell the fact” redux, then some easing of the dollar and move lower in yields should offset the expected liquidity tightening.

Broadly, I also still expect long duration to trade well. Slowing global growth and a backward-looking Fed maintaining “higher for longer” should keep a lid on longer-end yields, which can then continue their path lower and maintain a favorable tailwind for crypto into the year's second half.

Adoption Tsunami

Stepping outside of the macro, there are also some crypto-specific positive stories that will lend support. Hong Kong’s Securities and Futures Commission concluded its consultation on retail participation, and from the 1st of June, Hong Kong retail investors will be able to buy BTC and ETH on licensed exchanges. With Hong Kong widely seen as a testing ground for mainland policy, expectations are that China will soon follow suit. Adding to that expectation, China Central Television (CCTV) broadcasted crypto last week, which caught the attention of Binance’s CZ👇.

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China also released a white paper for Web3 innovation over the weekend to promote the industry’s development, with Beijing aiming to strengthen policy support and accelerate technological breakthroughs. Curious timing, perhaps just ahead of Hong Kong’s “go-live” for crypto. With the US increasingly hostile towards digital assets, the next wave of adoption looks set to come from the East… and it could well be a tsunami 🌊.

This weekend, Recep Tayyip Erdogan also won a historic third term in Sunday’s run-off election in Turkey. The authoritarian leader’s disastrous economic policies, which have driven inflation north of 100% and decimated the value of the Turkish lira (TRY), which now trades at a record low of over 20 against the USD, has seen TRY-denominated trade volume as a percentage of global fiat-denominated crypto volume grow rapidly to more than 15% according to Kaiko, with Crypto volumes spiking into the election👇.

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The case for decentralized, trustless forms of value exchange grows ever stronger. Moreover, the fact that a group of politicians in Washington would take the country to the edge of default to pursue their political agenda reinforces the value proposition.

Flows and vols

The positive spot/vol correlation seeing BTC and ETH vols pop higher, having hit new lows over the weekend. Friday saw a persistent upside BTC bid via bull 24k/28k risk reversals and skew across the curve from 30 days now trades for calls over puts, suggesting a still more bullish outlook for BTC. With the volatility risk premium (VRP) elevated (implied vols trading decently above realized), we’ll need momentum on this move higher to sustain; otherwise, we suspect implied vols to quickly fall back lower 😞.

Sadly, this is my expectation as the liquidity squeeze starts to take effect and weigh on broader risk in the coming days and weeks. It still feels like the “calm before the vol storm,” and without outright vols so low, it makes sense to perhaps own longer dated vol (30 day+) and pay for the theta bill by selling the front dates.

Caution then the watch word short term. Liquidity likely becomes a huge challenge throughout June, which, all else equal, will be bearish for crypto, especially if the dollar and US yields remain elevated. A difficult few weeks ahead with these competing narratives, but the longer-term bull thesis grows ever stronger and with the potential for a new wave of adoption from Asia, continue to look for opportunities to position for the topside. Patience frens 🫡.

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Sincerely,
David Brickell 💜