Last week’s Thursday’s data almost certainly confirms that the United States experienced two consecutive quarters of negative growth.
Now, two consecutive quarters of negative growth means a recession in the United States. But the US government will not admit a recession has occurred until the unemployment rate falls below 5%. (yet to happen).
This means that the Fed would be leaning to tighten policy until the labor market improves.
It is important to note that $btc and other risk assets have pumped higher on FOMC events this year, only to sell off after.
But is this time different?
The Federal Reserve raised interest rates by 75 basis points at its June meeting, the largest increase since 1994. More significant hikes are expected before inflation is ‘normalized.’
Since the June meeting, the overall economic environment has not improved significantly. Data has revealed that inflation has remained high and that the US labor market has remained strong.
Therefore, the Fed can and will continue to push until something breaks (labor market).
Yes, solid employment data is suitable for job seekers/employees, which you would think is bullish for risk, but this data also indicates that the Fed can push harder before the job market breaks meaningfully. This scenario is bearish for risk.
As long as US employment remains stable, the market will be on the lookout for tighter monetary policy shifts (sell the rally). The Fed understands that easing labor market conditions will help to reduce inflation.
The market is already reacting to the following key macroeconomic factors, which have largely gone unnoticed:
When people lose their jobs and have no money to spend, demand-side pressures ease and the supply-side can return to normal. Breaking the job market is their most powerful tool in combating 40-year-high inflation.
Recessions have historically been characterized by declines in employment, which typically begin with businesses slowing hiring. Such a slowing has yet to occur on a large scale. When it begins to happen, it’ll encourage further “sell the rally” in risk assets. Bitcoin will almost certainly struggle to break through 28k until this data becomes favorable for it.
Why is the emphasis on the labor market deteriorating?
This is because, it will indicate that the Fed is approaching or has reached its peak hawkishness, which will be followed by neutrality and dovishness. Currently, the market expects neutrality around June-July 2023, followed by dovishness.
I believe that the shift to neutrality will serve as the foundation for the next crypto bull market and that the shift to dovishness will result in an aggressive risk rally, sparking another cycle higher.
But first, the market anticipates 175bps of hikes and an aggressive Fed.
The market is currently positioned for a 75bps hike on Wednesday; speculation of a 100bps hike remains but has dwindled in recent days. Expect new lows in risk assets sooner rather than later if a 100bps hike is delivered, whereas a 75bps hike will likely result in more chop and frustrating price action.
During this recent rally, I started seeing some concerning signs in the volatility space. It’s worth noting that index volatility hedges have been one of the most supportive factors during this general downtrend.
The majority of the world was institutionally well-hedged, and the vol market was oversupplied. Summer was an interesting period: low liquidity + well-supplied vol = mean reversion and index-level vol compression, which is now coming to an end.
As the market has rallied, implied volatility (IV) on a fixed strike basis has begun to rise, unraveling this supportive index vol, which I expect to continue if the market rises.
Here’s this week’s calendar
Remember not to stick to losing trades, especially in a declining market where you would have expected to profit. The equity market has been primarily supported by two factors: bearish positioning/sentiment and index vol hedging. I’m seeing an increase in dealer positioning that isn’t overly hedged, but rather equally hedged.
Conclusion:
This is not to say that a rally cannot occur; however, a rally occurring here is actually bearish and opens the door for another, more volatile leg down.
If skew steepens and vol becomes in short supply, dealers won’t be providing supportive flows as they have and this will exacerbate the moves instead. There’s not a single bear market that just went straight down; the market demands more liquidity and patience than is available from its participants, hence the choppiness. Likely not unpinning this month, but the odds are increasing.
