Avantis Macro Series #3: End of the hiking cycle?
In this week’s macro update, we examine the impact of CPI , PPI and jobless claims data on the cross-asset rally, question whether the hiking cycle has come ot an end, and talk about developments across crypto prices and the CME. As always, please note that this is for educational purposes only, and nothing written here constitutes financial advice.
A cooler than expected CPI data release (3.2% vs 3.3% forecast) on Tuesday reinforced the market view that the hiking cycle is over and gave impetus to the ongoing cross asset rally. Bond yields fell sharply with a 20 bp rally in 5yr while the 10yr yield dropped to 4.46%, a move of ~60 bps over the last couple of weeks. Credit gapped up with both high yield and high grade corporate bonds ending the week higher. SPX also gapped up, continued on to 4500 and erased most of its losses since September, while the dollar index (DXY) fell the most in a year to the 104 handle which led to significant easing in financial conditions. This drop in yields and DXY combined was rocket fuel for small caps which rose ~7% before paring gains.
Jobless claims data on Thursday was also slightly higher than forecast which increased market optimism on a soft landing narrative (the labor market cools just enough to bring inflation under control, but not as much to cause a deep recession). PPI (Producer prices) also fell more than expected, which amplified the impact of the CPI report. With inflation data now on a more manageable trajectory, monetary policy is seen to be working with lags as expected and the market is extrapolating that to price in a soft landing. In fact, for the march meeting, the market is pricing in a ~32% probability of rate cuts !
The concern from some participants here is that the market is overestimating the FED reaction and pricing in a very dovish forward trajectory, which will lead to reversal moves later. The market is pricing in the possibility of ‘Insurance cuts’ in 2024 , i.e FED accommodation to maintain the level of restrictive policy settings and prevent accidental over-tightening as inflation falls. How tight or loose monetary policy is, is determined by the level of real rates, which automatically go up when inflation is falling (real = nominal-inflation). To maintain the same level of real rates, and thus the same level of policy settings, FED will need to cut to stand still. But the market is also pricing in a full retreat from restrictive policy settings and a possibility of FED panic on rising unemployment if a deeper slowdown occurs, especially in an election year.
Powell pushed back on the narrative and he wants to keep a 2 way policy risk in play by insisting that additional rate hikes are on the table, but the FED is also trying to thread the needle and ensure policy is not too tight to have a deep recession. Further trajectory will be data dependent, which at this point seems to indicate that the hiking cycle is over based on the trajectory of inflation and other economic indicators.
Crypto
The blistering crypto rally took a bit of a breather this week with Bitcoin consolidating in the monthly 35–37k range. It needs a further catalyst to break out and head towards 40k, with market expectations that an ETF narrative win will provide the impetus.
Exuberance around the ETF narrative took a hit when fake news of an XRP ETF led to a sharp spike in XRP price to 0.75, which retraced soon on confirmation that the news was fake. This tempered sentiment and expectations around altcoin ETFs, and put the focus firmly back on the ‘real’ narrative, Bitcoin ETFs which are almost certain to be approved before 10th Jan while altcoin ETFs will take much longer if ever.
Ethereum
ETH has retreated below $2000 and as the expectation around timelines on ETH ETF approval are tempered, the market is waiting for the next catalyst. ETHBTC has also dropped and is trading around 0.053 while BTC dominance has ticked back up as ETH and the rally in alts has cooled down.
Solana
Solana has continued to outperform the rest of the market among majors and remains firmly above the support at 45. The narrative remains positive with multiple ecosystem project airdrops and token launches expected and while the rally cools down and Sol consolidates a bit, and the market seems to remain bullish as long as the support region holds.
Another significant development was that futures volume on CME surpassed Binance for the first time, heralding a subtle structural shift underway in the market with the potential for significant amounts of new capital from tradfi coming into the space!
Read more from the author (and our macro researcher), Fractalmonk: https://medium.com/@fractalmonk999
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