The interest rate cut cycle has begun. Why is the crypto market volatile?

In addition to the new narrative in the crypto market, US dollar monetary policy is a key factor affecting market trends. Especially after the adoption of ETFs and the gradual entry of BTC and ETH into the asset layout of mainstream institutional investors, the market's capital structure, attributes, and investment methods are undergoing significant changes. Cryptocurrencies are increasingly competing with other major companies such as US stocks, US bonds, and gold. Class assets form some kind of resonance or differentiation.

In recent times, the market has repeatedly fluctuated among interest rate cut expectations, recession expectations, and election expectations. This essentially corresponds to the financial, fundamental and regulatory aspects. , three factors are intertwined and influence each other. The most direct impact of this is interest rate cuts and interest rate cut expectations. To a certain extent, in a small cycle, interest rate cut expectations are more important in transactions than the interest rate cut itself, so it is particularly critical to sort out the upcoming interest rate cut in mid-to-late September.

1. Why the rate cut: Tightening stems from high inflation, but interest rate cuts stem more from the slowdown in the labor market

Leverage differentiation under high inflation in the United States: the government increases leverage and residents deleverage to support the resilience of the U.S. economy. There is not much disagreement in the market about the reasons for high inflation. The core reason is the overly aggressive fiscal policy of the United States in recent years. While radical fiscal policy has injected a large amount of liquidity into the market, on the one hand, the Federal Reserve has rapidly expanded its balance sheet and the government deficit has grown significantly; on the other hand, the liabilities of the household sector and non-financial corporate sector have not increased significantly, but have improved.

Chart: The leverage ratios of the three major sectors in the United States are divergent, and the household leverage ratio is declining

The leverage ratio differentiation further explains that although the spread between the 10-year and 2-year U.S. Treasury bonds, which is a forward-looking indicator of recession, began to invert in July 2022, it lasted for a total of 26 months, which was the longest in history until In August this year, the labor market slowed down, and expectations of interest rate cuts led to a decline in short-term interest rates, thus lifting the inversion, but recession has not yet arrived.

Chart: This round of interest rate hikes has the longest U.S. debt inversion in history, exacerbating market concerns

The data does not support a recession, but the slowdown in the labor force and worsening data quality have strengthened expectations for interest rate cuts and also raised concerns about recession. In terms of inflation, the current PCE (2.5%) and core PCE (2.6%) have not reached the Fed's target of 2%, but traders on Wall Street generally expect that the Fed will cut interest rates in September. In addition to Powell and Fed officials continuing to In addition to the market's dovish voice, another important background is that in the Federal Reserve's monetary policy framework in 2020, the original inflation target system was changed to an average inflation target system. At the same time, although employment and inflation are still the main balance of the Federal Reserve, dual goals, but employment and the labor market are obviously given priority. In other words, the Fed is more willing to tolerate short-term high inflation to ensure the stability of the labor market.

Changes in the monetary framework are further reflected in each of its FOMC meetings and its expected management of the market. Non-farm employment, unemployment rate and other data Every announcement will cause repeated fluctuations in the market, and risk assets such as U.S. stocks and cryptocurrencies will fluctuate violently. It is not an exaggeration to describe the current market as turbulent. The market is highly sensitive. In addition to betting on expectations of interest rate cuts, it is also overlaid with concerns about recession and concerns about the sustainability of the AI ​​narrative represented by Nvidia.

From the data point of view, the current U.S. economy has not fallen into recession, but it is slowing down faster than expected and the quality of employment is not high. There have always been different opinions on the judgment of recession. A simple and effective indicator is Sam's rule. Its basic definition is when the three-month moving average of the U.S. unemployment rate rises by 0.5 percentage points or more from the low of the past twelve months. time, which means that the United States has entered the early stages of economic recession. According to this indicator, the United States has entered recession since July this year (the recession indicator under the Sam rule in July was 0.53% and in August was 0.57%). However, mainstream institutions including the Federal Reserve do not believe that it has entered a recession.

Using the more authoritative NBER recession indicator to observe, currently GDP, employment, industrial production, etc. all have a small retracement, with a 3-year retracement range. Less than 2%, far lower than the 5%-10% level during the historical recession.

Chart: NBER recession indicator is still far from recession range

The slowdown in the labor market puts more pressure on the economy. The most critical indicator of U.S. employment data is NFP data (non-farm payroll data), which is released by the U.S. Department of Labor’s Bureau of Labor Statistics (BLS). Looking at the breakdown of data in the past three months, manufacturing data has been a heavy drag, mainly supported by the service industry and government departments. In addition, the U.S. Department of Labor also revised downwards the previous data in August and September. The magnitude of the revision surprised the market. According to the revised data, from January 2024 to August 2024, the average new The increase in non-agricultural employment was only 149,000, significantly lower than the average of 175,000 in 2019.

Chart: Non-farm employment has slowed significantly in the past three months

Further looking at the type of employment, there is also a clear differentiation between full-time and part-time jobs. Full-time positions in the United States continue to decrease month-on-month and year-on-year, while part-time jobs increase month-on-month and year-on-year. The increase in part-time jobs has concealed the decline in the total number to a certain extent, but it also reveals that the quality of employment data is not high.

Chart: Changes in the number of full-time and part-time people in the United States suggest that the quality of employment data is not high

In terms of unemployment rate, with the labor force participation rate remaining flat, the unemployment rate has increased to 4.3%, but has fallen back, and the Sam Rule Index continues to rise. Among the unemployment data, what is particularly noteworthy is that the U6 unemployment rate (a broader unemployment rate, close to the true unemployment rate of the entire market) has risen to 7.9%, the highest level after the epidemic. In addition, in terms of job vacancies, Job vacancies fell more than expected, and the vacancy rate also continued to decline.

Chart: JOTS non-agricultural job vacancies continue to decline

The job market has cooled for two consecutive months and the previous employment data has been revised downwards. On the one hand, market interest rate cut expectations have been greatly strengthened, with the focus only on 25bp/50bp; on the other hand, concerns about recession have begun to heat up.

2. How to drop: The game between the market and the Federal Reserve, but data is still the key

After the release of the non-agricultural data on September 6, the market's performance vividly demonstrated the mixed results in the data and the divergence in market consensus; risk assets had mixed gains and losses, but ultimately were weak. The August CPI data released on the evening of September 11 was released. Although it fell back to 2.5% year-on-year, lower than expected, the core CPI increased by 0.3% month-on-month, higher than market expectations. Overall inflation continued the previous structural differentiation, with commodities and food , Energy continues to fall, and services are still highly sticky. After the data was released, the market's expectations for a 50bp interest rate cut were significantly reduced. The stickiness of service inflation also indirectly shows that there is currently no risk of recession.

Chart: July-August CPI breakdown reveals that inflation is still highly sticky and the rate of decline is slowing

The market's continued concerns about recession, coupled with falling inflation, and the intertwining of the two factors, have caused the market to be very "entangled" in interest rate cuts. The main reason is that the current market consensus cannot be unified and is full of contradictions. If the interest rate is cut by 25bp, on the one hand, the pricing is very sufficient and the boost to risk assets will be limited. At the same time, it will not be able to completely reverse the market's concerns about recession. If the interest rate is cut by 50bp, then the market's concerns about recession will increase significantly, which in turn will constrain risky assets. Boost. In either case, the immediate impact on the market is a significant increase in the sensitivity of risky assets.

From the perspective of the Federal Reserve, in essence, its regulatory methods mainly include market expectation management and monetary policy management. The former relies on propaganda, while the latter relies on real policy tools. Currently, although the Federal Reserve has not actually cut interest rates, the continued announcements by officials including Powell have formed loose expectations for the market. Both U.S. bond yields and credit interest rates in the U.S. domestic market have reacted in advance, and Form substantial easing.

Chart: The proportion of U.S. bank credit tightening has declined and credit spreads have narrowed

For example, in the picture above, the proportion of U.S. banks tightening loans has been significantly reduced, credit risk spreads have been declining since August 5, and the market is clearly easing.

Based on the current slowdown in inflation, the unexpected slowdown in the labor market and the substantial loose environment, the possibility of opening 50bp on September 18 has begun to decline. , the probability of a precautionary interest rate cut by 25bp is enhanced. Looking further, in the absence of clear data proving that a recession has arrived or that inflation has dropped sharply beyond expectations, a soft landing is still the baseline scenario for current trading, and the market will still remain volatile amid data fluctuations from recessions, interest rate cuts, elections and other events. .

3. What is the impact: Crypto risk appetite is boosted, but adjustments are inevitable

Even though it is widely expected that the FOMC meeting on September 18 will soon start an interest rate cut cycle, risk assets will not necessarily show an immediate upward trend, especially since entering 2024, as Bitcoin and Ethereum ETFs are listed in the United States and Hong Kong , the process of cryptocurrency compliance not only allows mainstream funds to begin to allocate crypto assets, but also further weakens the independent market of crypto assets. Crypto-assets are greatly affected by the fluctuations of major assets such as U.S. stocks and U.S. bonds. From the perspective of the transmission of interest rate cuts, they directly impact the risk-free government bond market, which in turn affects risky assets (MAGA7, Russell 2000, SP500, crypto assets).

Changes will affect the effect of valuation, thereby affecting the rise and fall of assets.

In terms of different types of interest rate cuts, past preventive interest rate cuts usually caused risk assets to first drop, then bottom out, and then resume rising (and if Relief-style interest rate cuts usually have a higher probability of asset decline), and the bottoming time usually takes one month.

Chart: When preventive interest rate cuts are implemented, risk assets usually fall first and then rise

For crypto assets, as high-risk assets, they are currently more and more closely linked to the US stock market. Under the scenario of relatively certain interest rate cuts and soft landing, the market's risk preference should gradually increase, but as analyzed above , currently in the divergence stage before the formation of a new consensus in the market, shocks are inevitable, whether it is US stocks or crypto assets.

Chart: Cryptoassets and U.S. stocks fluctuate in highly consistent directions

Observed from the long-term scenario, the winning rate of crypto-asset rises is still high, but in the next month, volatility will still closely follow the US stock market and remain volatile, especially before and after the interest rate cut is implemented, the volatility may further increase. In addition, what is still worthy of attention is the impact of the US election. The results of the election will directly affect the attitude of the government, including the SEC, towards cryptocurrency, which will in turn have an impact on the market.