The Temporary Farewell to High Volatility Cycle: Weekly Market Review From Blofin
- The results of the FOMC meeting in March did not exceed investors' expectations. Due to the exhaustion of bear news, the volatility of the crypto market has rapidly dropped to a relatively low point in the year.
- It is unlikely that volatility will remain high in April. However, the effectiveness of the Fed's policies may add uncertainty to the performance of cryptos in May, thus pushing up volatility again.
- The quarterly delivery of derivatives in the crypto market may bring some uncertainty, but the overall fluctuation range will remain medium-low.
The Shoe Dropped, The Market Stabilizes
The FOMC meeting on March 17 announced the interest rate hike without question - the heaviest stone fell to the ground. Although the Fed's interest rate hike announcement officially opened the process of liquidity contraction, since investors have already priced seven interest rate hikes in advance, this interest rate hike has not caused significant disturbance to the market.
In addition, because the shrink of the balance sheet did not start in May as expected, investors also regarded the Fed's attitude as "actual dovish". If the Fed policy continues to up the ante on the current basis, it may trigger an actual recession without inflation being resolved. Based on this judgment, the bearish sentiment in venture capital markets has shown signs of reversing for the first time, and the prices of risky assets have also begun to rise again.
For crypto-assets, with the release of the Federal Reserve's decision, the severe market turmoil that lasted for nearly a month finally ended. From the perspective of market value, compared with the first half of March, the total market cap of crypto-assets declined steadily, stabilizing at $1.75- 1.85T around Mar 21. From the perspective of the options market, the one-month upward process of implied volatility also ended on March 17. This is a rare opportunity to sell volatility for options traders, and many block volatility trading orders began to appear.
It is worth noting that the skew of options in recent months has recently returned to neutrality-this is the first time since the beginning of the year. This is an essential signal of investor confidence's return.
However, from the perspective of futures traders, the current market sentiment has not significantly impacted investor expectations. The front-month futures premium is still basically the same as the spot, while the premium of far-months futures remains around 4%, which is a significant decline from last month. Considering the impact of the economic cycle on the futures and spot markets, it is not difficult to predict that the upper-performance limit of the crypto market is still decreasing as liquidity shrinks.
When Will the Crypto Bottom Out?
To be sure, the crypto market has just plateaued. The liquidity contraction is not over, and short-term asset prices supported by confidence rather than liquidity will still show a downward trend with the arrival of further interest rate hikes. However, the appearance of severe stagflation seems to bring some variables to the performance of crypto assets.
Shortly after the FOMC announcement, the interest rate market's forecast of the total number of interest rate hikes this year fell sharply. The latest economic data released showed that the economy was already showing signs of recession. The inversion of the yield of 5-year and 10-year bonds further showed that bond investors are worried about medium-term macroeconomic risks.
Suppose the Fed raises interest rates several times and hopes to control inflation through a short-term recession. In that case, it is likely that within 2-3 years, the economy will reach the limit it can bear, and at this time, the Fed will have to start rereleasing liquidity, just as they did around 2018.
Inflation may be controlled, but regardless of whether inflation eventually reaches its target, each interest rate hike may trigger further pricing of recession in the interest rate and debt markets, which in turn will cause further damage to an already frustrating economy. So, two years may be the "max period" for hawkish policies of the Federal Reserve.
How to Trade?
In the short term, inflation data may be the focus of attention. The peak of the inflation-induced bull market in 2021Q4 is still fresh in memory. With the Federal Reserve vowing to curb inflation through policies, most investors expect the inflation-suppressing effect of interest rate hikes. The impact of the first interest rate hike in mid-March is challenging to show in the CPI data in March, but after the end of April, there will be some conclusion on whether the interest rate hike is effective.
The CPI data released in mid-May may therefore be a critical juncture. If the data improves, the Fed may lean towards the moderate line. However, if the CPI data does not improve, the Fed will be in a dilemma. They may increase policy efforts to try, but the economy just emerged from the epidemic is still fragile, and excessive policy adverse effects may be devastating. The Fed needs to find a "balance".
No matter what the Fed does for the crypto market, since investors cannot see the policy effect in April, the probability of high volatility caused by macroeconomic policy changes in April is not very high. Considering the characteristics of crypto assets as secondary risk assets, the crypto market may price uncertainty ahead of other markets. The pricing in April will tend to be moderate; however, high volatility caused by increased uncertainty in May is inevitable.
The US debt yield curve may be more important for investors in the medium and long term. A recession caused by interest rate hikes seems inevitable, and investors' pricing of risky assets will continue to move downward due to the recession. The bond yield curve is an external manifestation of investors' prediction of the extent of economic recession. Since the economy has limited tolerance for recession, the moment when the historical bond yield upside-down ceiling appears is the best time to enter the market and buy crypto assets.
March 25 is the quarterly witching day for crypto derivatives. Before that, key Fed officials, including Powell, will make intensive speeches this week, which may bring some uncertainty to the delivery. However, as the downward pressure has been released and the market is gradually returning to neutrality, the possibility of a short-term jump in volatility is low. With the advent of a low volatility cycle, April will be a relatively appropriate option buying time for investors.