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"Hang on"
Aurelie Barthere
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Key Takeaways
9 min read
  • We see a high risk for the US terminal rate to be revised higher than 5.25%-5.5%, which is what several Fed voting members have hinted at last week
  • Fed Chair Powell's messaging and US labor data reporting this week will be key to confirm this projection
  • The combination of a potentially higher US terminal rate, and many regulatory inquiries is not exactly a tailwind for crypto
  • BTC prices hang by a thread (narrow range between 22,160 and 22,642 since Thursday)
  • If Silvergate reports "just" a lower-than-5% capitalization ratio, prices can maybe hold. A bankruptcy would probably lead to lower prices
  • The interesting part is crypto price sensitivity: crypto prices have been relatively resilient despite the accumulation of “bad news"
  • The regulatory wall-of-worry will take some patience to climb (probably most of 2023 and some of 2024)
  • On Macro, we need rates to go lower: A 5.5%+ yielding US Treasury bill is more attractive that most risk assets, including crypto
  • Lower rates would only probably come after "something breaks" (see ongoing negative newsflow on REIT vehicles and latest default of Blackstone commercial-real-estate-backed bond)

"Hang-on"

BTC prices hanging by a thread
Source: BTC prices hanging by a thread

Hot European inflation and global services economy in full bloom

France, Spain, Germany, Italy all reported higher-than-consensus CPI prints for February, leading to an aggregate for the Eurozone of 8.5% YoY vs 8.2% expected, and barely 10bps below January. Talk about “sticky”. The following drivers are at play:

  • Energy inflation is coming down but still tracking at ~14% YoY
  • Food inflation (~15% YoY) is still up because it is lagging energy. It will very likely weaken at some point this year (global FAO food indices have come down)
  • Core inflation remains sticky at 4.5% - 6% YoY. This will be the battleground of the European Central Bank (ECB), this and historically strong wage growth

The PMIs (Purchasing Managers Indices) sent the following messages around the global economy:

  • The manufacturing sector is muddling through (e.g. no talk of recession any more, but weakness expected at least until H2 2023).
  • China is the outlier of-course: the Caixin manufacturing PMI is up 2.4pts, above contraction (51.6 in February). Interestingly, the signs of positive spillovers to neighboring countries (Korea, Taiwan) are small so far. This might indicate a delayed effect or a modest positive spillover on global manufacturing.
  • What is more, last week’s Chinese National Party Congress set relatively modest targets on GDP growth for 2023 (5% vs 5.5% target for 2022) and fiscal deficit (3% target vs 2.8% for 2022).
  • We speculate that the large infrastructure and property boom that occurred in China after the Global Financial Crisis in 2009 is unlikely to be repeated. The balance sheets of State-Owned-Enterprises (SOEs) and property developers look different today, with bad property loans still being restructured by the authorities and Chinese public banks.
  • But the services sector is doing well in China (Caixin services PMI up 2.1pts to 55) and globally. The Chinese saving rate as % of GDP is up by 5 %pts compared to pre-2020. These savings are likely to be spent on recreational services and tourism, if the post-covid re-opening in the rest of the world is any guide (good for services exporters like Thailand).
  • We highlight services in the rest of the world which are also prospering, notably in the UK and Japan (services PMI at 54 and retail sales up 6.3% YoY). Not coincidentally, European and Japanese equity markets took the equity performance leadership last week.

Implication for US, European, Japanese rate markets

Europe The 1yr EURIBOR is up ~18bps week-on-week to 3.83% as a result of strong European inflation. We see a high likelihood of the ECB going for two consecutive 50bps hikes in March and May: it will take time for food and core inflation to slow, the labor markets are still tight, and President Largarde is hawkish (more so than the neighboring Bank of England Governor).

Japan Robust growth and rising wage growth make for a likely further adjustment of the yield curve control (will Governor Kuroda dare adjust in his last meeting this week?).

How about the US Fed?

Currently bond futures are pricing three consecutive 25bps-rate hikes in March, May, and June to bring the terminal rate at 5.25%-5.50% or in agreement with the latest Fed’s Summary of Economic Projections (SEP). The SEP will be updated at the next FOMC meeting on March 16-17. We see the risk of the terminal rate being revised higher, which is what several Fed voting members have hinted at in last week’s speeches. President Waller’s words summarize the change in mental representation from “desinflation” to “sticky inflation” best: : [“inflation is not coming down as fast as I had thought. It could be that progress has stalled, or it is possible that the numbers released last month were a blip [...] Fortunately, we will get the next employment report and CPI release ahead of the March 21–22 FOMC meeting, information that will affect my assessment of the appropriate next step for monetary policy. [...] if those data reports continue to come in too hot, the policy target range will have to be raised this year even more [than the 5.1-5.4% range] to ensure that we do not lose the momentum that was in place before the data for January were released.”](https://www.federalreserve.gov/newsevents/speech/waller20230302a.htm)

Data dependency

Regardless of how “hot” the next job data release is, we see an asymmetric pricing: 25bps is priced at 70% for March, but the probability of a 50bps-rate is superior to 30% in our view.

Let’s cover the upcoming February job data releases, from job openings to payrolls. US Indeed statistics provide a valuable timely health check of the US labor market: Indeed job openings have slowed ~4% MoM in February. If we transpose this rate to the JOLTS job openings data, this would bring us to an estimate of 10.57m, from 11.012m last month. The consensus is close at 10.5m job openings. This would suggest a muted reaction post JOLT releases. Indeed highlights that quit rates remain at historical highs, lay-off rates are low, and wage growth is slowing albeit still at high levels (4% to 6% YoY) vs a desired rate of 3% expressed by Fed Chair Powell.

The consensus for February non-farm payrolls, at 200k seems particularly low given the prior monthly gains, and is vulnerable to upside surprises.

Indeed job posting down 4% MoM but still 50% above pre-covid levels
Source: Indeed job posting down 4% MoM but still 50% above pre-covid levels

The REIT canary

Employment data are late-cycle and for leading indicators, one has to look at financing and lending conditions. Financing conditions are becoming difficult for rate-sensitive sectors, which have historically benefited from 15 years of low-rate regime. Residential real estate demand is cooling, and commercial real estate and illiquid vehicles giving exposure to the sector appear especially vulnerable. The most straightforward script is for high neutral rates (T-bill at 5.3%+) to make lower-yield, riskier, less liquid assets unattractive. We wonder if REIT funds cash gating are the canary in the coal mine of this bizarre cycle:

Markets: bonds take a breather, Chinese assets react mildly to strong PMIs

After days of bear-steepening, much has been written about long-end US rates (e.g. 10yr) retracing lower (the US 10yr yield crossed above 4% on March 2nd and then fell by 10bps to 3.92%) as we write. It is possible that markets are starting to price growth and inflation weakness in the long-end, but there is not enough evidence on this yet, neither in markets nor in fundamental data (outside of real-estate).

The reaction to buoyant Chinese PMIs, from copper to AUD/USD has been relatively tame. The AUD/USD has resumed its downward trajectory as we write. This could indicate some skepticism from investors around the potency of China’s reopening. And it would indeed be confirmed by the modest GDP and fiscal spending targets for 2023. We reiterate that if there is a boom in spending, it looks more likely to impact services than property or infrastructure spending. There is also a lot of geopolitical uncertainty surrounding China’s role in the Ukrainian war (the US government “leaked” that China could potentially provide weapons to Russia). Germany Chancellor Scholz declared that if China were to aid Russia: “I think it would have consequences, but we are now in a stage where we are making clear that this should not happen, and I’m relatively optimistic that we will be successful with our request in this case, but we will have to look at and we have to be very, very cautious.”. Chinese assets might also be pricing the negative geopolitical news.

Crypto: the Silvergate’s “red candle”

And we finally come to crypto markets. The combination of a potentially higher US terminal rate, and many regulatory inquiries is not exactly a tailwind. However, we wrote last week about crypto prices’ resilience despite the accumulation of “bad news.”

Can crypto sustain an additional shock, e.g. Silvergate bank going out-of-business?

This is hard to say: right now BTC prices have reacted with one down-price candle of -4.9% on Thursday 3 March. Since then, BTC prices have traded in a narrow range between 22,160 and 22,642. This narrowing usually precedes a large move.

Silvergate: contrary to when an exchange fails, a regulated bank has its depositors (capped at USD 250k) insured by the FDIC. What brought about Silvergate’s difficulties? 1) A concentration of deposits among one sector, crypto (contrary to a more diversified bank deposit profile), 2) Regulatory woes following its involvement with the Alameda-FTX entities. These fragilities make the bank especially vulnerable to the deposit run that we are witnessing. As of December 31, 2022, the bank held ~USD 13bn in short-term liabilities and customer deposits vs roughly the same amount in debt security assets and short-term borrowing. What likely happened YTD is a loss in the fire sale of its debt securities (it looks like the bank might have taken duration and credit risk in its “debt security” portfolio) to cover client withdrawals.

BTC prices hang by a thread. If Silvergate reports "just" a lower-than-5% capitalization ratio, prices can maybe hold. A bankruptcy could lead to lower prices.

The regulatory wall-of-worry will take some patience to climb, here are a few other events to pay attention to: regulators’ approach of Signature bank, what the multiple articles around Binance’s past “shadow practices” mean for Binance’s outlook in the US (at a minimum a settlement with the SEC in our view), see Texts From Crypto Giant Binance Reveal Plan to Elude U.S. Authorities.

In the meantime, positive newsflow on the tech development front continues in the background, with the latest being the release of the standard EIP-4337, which brings the possibility of account abstraction and therefore easier-to-manage identification processes on-chain.

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Disclosure: The authors of this content and members of Nansen may be participating or invested in some of the protocols or tokens mentioned herein. The foregoing statement acts as a disclosure of potential conflicts of interest and is not a recommendation to purchase or invest in any token or participate in any protocol. Nansen does not recommend any particular course of action in relation to any token or protocol. The content herein is meant purely for educational and informational purposes only and should not be relied upon as financial, investment, legal, tax or any other professional or other advice. None of the content and information herein is presented to induce or to attempt to induce any reader or other person to buy, sell or hold any token or participate in any protocol or enter into, or offer to enter into, any agreement for or with a view to buying or selling any token or participating in any protocol. Statements made herein (including statements of opinion, if any) are wholly generic and not tailored to take into account the personal needs and unique circumstances of any reader or any other person. Readers are strongly urged to exercise caution and have regard to their own personal needs and circumstances before making any decision to buy or sell any token or participate in any protocol. Observations and views expressed herein may be changed by Nansen at any time without notice. Nansen accepts no liability whatsoever for any losses or liabilities arising from the use of or reliance on any of this content.