Market View
Central banks: Speak loudly, say nothing?
The bi-partisan “Financial Innovation and Technology for the 21st Century Act” (HR 4763) made some key advancements in the US House Financial Services and Agricultural Committees in Congress this week, but we saw very little response to those developments from crypto markets.
In fact, with fewer crypto-specific catalysts amid the summer slowdown, performance in the asset class seemed to take its cues from the stronger USD trend and corporate month end flows. The multilateral USD index (DXY) bounced off its 12m low last week on the back of favorable dollar seasonals as well as the widening economic divergence between the US and the rest of the world, reflected in interest rate differentials.
This week, the Federal Reserve unanimously hiked rates by 25bps to 5.25-5.50%, which had been widely telegraphed. But in our view, the net amount of new information introduced at this meeting was far more limited than in any previous session over the last year. Ex-post real yields in the US are now higher than they were prior to the pandemic, but Fed Chair Jerome Powell made it clear that the board was a long way off from rate cuts.
We still believe that Powell has a dovish bias here, but he stated that the Fed’s next decision on September 20 will be data dependent, with two CPI prints and the Jackson Hole Summit to watch before then. That hawkish tone seems to reflect the lack of unanimity among the board, in our view. Meanwhile, the ECB followed the Fed with its own 25bps hike on July 27 taking the deposit facility rate to 3.75% (and the refinancing rate to 4.25%). Despite ECB President Christine Lagarde saying that there’s still “ground to cover” on inflation, she remained non-committal on any forward guidance and suggested data dependence for their September meeting as well.
The key differences between the central banks is that:
- where the Fed upgraded their economic outlook to expanding at a “moderate” rather than “modest” pace, the ECB said that their near-term economic outlook has deteriorated and
- where there has been a clear disinflationary trend in the US, prices have been far stickier in Europe.
Our impression is that the ECB’s nervousness about the region’s economic outlook will likely be the dominant factor in their decision making, putting them in a more dovish space than the Fed. Consequently, we think that that juxtaposition should contribute to a stronger USD for the time being, which makes it difficult for cryptocurrencies to break higher in the near term. At the moment, BTC/USD is performing in line with the EUR on a risk-adjusted basis but outperforming the JPY and EMFX, based on its standard deviation move over a three-month period.
On derivatives, bitcoin options open interest has been down sharply in July, currently around 370k BTC (US$11B). That has coincided with the faster pace of implied volatility deceleration over the last 4-6 weeks as the 1m ATM level currently sits near 34% versus a realized vol of 30%. Still, we have seen disproportionate demand for bitcoin call options with a max pain price of $29,000 for the maturing July 28 contract on Deribit. That demand has kept the skew curve inverted since late June, with the 25 delta 1-month skew pushing lower in the last week from -3.5% to -9.2%. We think it’s likely the curve also flattened due to possible profit taking on positions after bitcoin rejected the $31,000-$32,000 spot level.
Meanwhile, futures open interest for bitcoin has been stable near 472k BTC ($13.8B) after picking up at the end of June, with institutional players increasing their participation on CME.
