Market View
Macro scenario in 1H24
We believe the market may be approaching an inflection point for sentiment as concerns over higher bond yields appear to be subsiding alongside the relevance of the Federal Reserve’s policy stance. It seems less likely that the Fed will hike rates on either November 1 or December 13 as many board members have said that the recent steep increase in long end bond yields have already served to tighten financial conditions significantly. That explains the market’s underwhelming response to September’s US CPI print, which showed a modest increase for headline inflation (3.7% YoY) but indicated core inflation continues to trend lower at a pace of 4.1% YoY. Our out-of-consensus view is that inflation has already peaked and that prices are on a disinflationary trend. See chart 1.
Meanwhile, we think the gradual withdrawal of fiscal stimulus may impact the US economy starting in 1Q24, though funding allocated to states and local governments by the end of this year will likely still be available for spending through 2025.
In our view, that combination of high rates and diminishing returns from fiscal expansion may put enough stress on the US economy to finally trigger a recession in 1H24. How crypto would react in that environment is challenging because a recession may impede capital deployment while multilateral USD performance remains an unresolved variable. The latter in particular depends not just on interest rate differentials but on how the rest of the world might be doing at that time. (Not to mention that on the political front, gridlock in the US House of Representatives could still trigger a government shutdown on November 17.) Our best guess is that while the knee jerk reaction to this scenario may initially be negative for crypto, we ultimately expect a better environment for long duration assets to emerge sooner rather than later, as we anticipate more accommodative monetary policy in 2Q24.
Empty Queues
For the first time since the Shanghai upgrade in May, the Ethereum validator queue has emptied out, signaling a plateau in investor demand for Ethereum staking. With the validator entry at peak capacity for the last several months, staking yields have dropped an average of 0.1pp per week from over 5% to its current level of 3.5%. The yield on staked ETH provides a floor for the crypto ecosystem, in our view, providing a benchmark for alternative crypto investments. Although that may not sound competitive against an opportunity cost of over 5% nominal on US Treasury bills, the real ETH staking yield of 3.2% (that is, subtracting 30d annualized supply growth of 0.32%) compares favorably with ex-ante real yields of 3.1% on US debt. If the underlying activity and transaction fees remain consistent, we expect the staking yield to remain relatively steady now that validator growth has slowed.
Throughout the 3Q23, activity on the Ethereum mainnet has remained flat, while its total rollup transactions have increased. With no major Ethereum protocol upgrades until Dencun, which is likely to occur in the first half of 2024, we see no major technical drivers that would meaningfully impact onchain activity – barring major new protocols or egregious hacks.
