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Stocks closed higher Friday following a strong monthly jobs report to clinch a sixth straight week of gains, with the S&P 500 and Nasdaq Composite hitting their highest closing levels since early 2022. Analysts said the Labor Department's report that November added 199,000 jobs on a seasonally adjusted basis likely keeps the Federal Reserve on pace to hold rates steady at next week's meeting.
A survey of U.S. consumers found that their expectations for inflation fell to the lowest level since March 2021. The University of Michigan reported on Friday that its December sentiment survey found that consumers expect the annual inflation rate to be about 3.1% 12 months from now, down sharply from the 4.5% figure in the November survey.
For the week, the Nasdaq climbed 0.7%, the SP500 added 0.2% and the Dow Jones average finished flat. The focus now turns to the Federal Reserve's last monetary policy committee meeting of the year next week. Markets are widely anticipating the central bank to hold steady on rates.
The price of U.S. crude oil slipped below $70 per barrel on Wednesday to the lowest level in more than five months. Oil climbed back above that threshold later in the week but remained far below a recent peak of around $89 on October 20. The price of gold futures surged on Monday, at one point climbing above $2,100 an ounce for the first time ever. However, that level wasn’t a record on an inflation-adjusted basis, and the price spike reversed course later in the day. For the week, gold was down more than 3% overall but still above $2,000 per ounce. The price of Bitcoin jumped to the highest level since April 2022. Bitcoin on Friday was trading around $44,000, up more than 13% for the week.
Investors will be focused on the last Federal Reserve meeting of the year next week. While the FOMC is expected to hold rates steady, the tone from Jerome Powell and gang will still be of high interest to market watchers. As it stands now, the Fed's favored inflation gauge, core PCE inflation, looks on track to end the year comfortably below the central bank's forecast and not too far off the Fed's 2% target.
Outside of the Fed meeting, this week will be the capstone of 2023 because whatever happens this week will be a send-off message as 2024 approaches. This week will feature CPI, PPI, and retail sales and industrial production on the economic front. A 3,10, and 30-year Treasury auctions and to finish it off, it will be quadruple witching options expiration on Friday.
Monday morning started on a negative note with a massive price dump that drove the largest cryptocurrency south hard. Bitcoin was trading steady at around $44,000 before the bears took control over the market and initiated a massive dump that drove the asset to a weekly low of just under $41,000. With most altcoins in a similar freefall state, the total value of liquidated positions has skyrocketed to over $400 million on a daily scale. The altcoins are in no better shape, as Ripple, Cardano, Polkadot, Chainlink, Shiba Inu, and many others have dumped by over 6% in a day. Avalanche is the only larger-cap alts sitting in the green now.
Macro y news
This Week's Major U.S. Economic Reports:
We have two weeks ahead of us loaded with highly sensitive macro data:
▪️ CPI 12/12
▪️ PPI 13/12
▪️ FOMC rate decision 13/12
▪️ Quad witching for options 15/12
▪️ Final Q3 GDP 21/12
▪️ PCE 22/12
U.S. Macro data
Friday’s closely watched nonfarm payrolls report surprised modestly on the upside, with employers adding 199,000 jobs in November versus consensus expectations of around 180,000. The unemployment rate also surprised by falling back to 3.7% from a two-year high of 3.9% in October. Average hourly earnings rose 0.4%, above expectations, but the year-over-year increase remained at a consensus 4.0%.
The bigger surprise, and the bigger market reaction, seemed to be the University of Michigan’s preliminary gauge of consumer sentiment in December, which jumped to its highest level since August on calming inflation fears. Survey respondents expected prices to increase by 3.1% in the coming year, down sharply from 4.5% in November and the lowest rate since March 2021. Gauges of consumer expectations and their assessment of current economic conditions also rose considerably.
The rest of the week’s economic data were mixed. On Tuesday, data from both S&P Global and the Institute for Supply Management showed a modest pickup in services sector activity in November, but the Labor Department’s count of October job openings fell much more than expected to 8.73 million, the lowest level since March 2021. October factory orders, which were reported Monday, also fell more than expected.
BONUS: November CPI
This week's inflation data will help to shape how fast inflation is coming down and whether the path is sustainable. Since June, inflation has been stuck in this 3% to 4% range, which isn't surprising, as inflation has become more sticky and stubborn.
At least for November, analysts see CPI flat on a month-over-month basis, which aligns with the October reading while rising by 3.1% y/y, down from 3.2% in October. Core CPI is expected to remain elevated and climb by 0.3% in November, up from 0.2% in October, while rising by 4.0% y/y in line with October. Inflation swaps are projecting the CPI to rise by 3.13%, and Kalshi is projecting a y/y increase of 3.12%. Meanwhile, Bloomberg Economics and the Cleveland Fed are projecting an increase of about 3.0%. The October CPI report came in below all of the estimates.
If CPI comes in as expected, then the current path of projections suggests that headline CPI will fall to around 2.5 to 2.7% by the end of 2024. This means that progress on inflation will be slower in 2024 than the progress that was seen in 2023.
But what is important is what the bond market is currently pricing where it sees real rates, and right now, the market is pricing real rates above 2% for the foreseeable future based on the real yield curve. Assuming that both PCE and CPI inflation rates come down to around 2.5% on a headline in 2024 as the Fed projects, and the current 2-year real yield is at 2.7%, it seems to suggest that the Fed Funds rate for 2024 should be around 5.2%, which means that the FOMC SEP for 2024, should be unchanged at 5.1%.
Additionally, if PCE comes down to the Fed's projected 2.2% in 2025, and real rates are to stay above 2%, then it would suggest that the Fed is likely to increase its 2025 Fed Funds rate target to 4.2% or higher from its current projection of 3.9%. The market is forecasting a Fed Funds rate of 3.7% in 2025.
The other metric is the longer-run rate, which currently stands at 2.5%. There has been great debate in recent months about the long-run neutral rate of the economy, and the Fed central tendency for that rate expanded in the September FOMC meeting to a range of 2.5% to 3.3% from 2.5% to 2.8% in June. It seems likely, given the strong GDP in the third quarter and the stronger-than-expected November jobs report coupled with a string of health job reports, we may see the weighted average move higher. Overall, this moved the weighted average in September to 2.75% from 2.66% in June.
It makes sense for the Fed to cut the rate some in 2024 and 2025 as the inflation rate drops to keep policy from becoming more restrictive as inflation falls. It isn't likely that we will see rates fall as much as the bond market has priced in.
BONUS: Preview of the last FOMC Meeting of 2023
The week ahead is chock full of central bank meetings. Among the G10 central banks, the Federal Reserve, the European Central Bank, the Bank of England, the Swiss National Bank, and Norway's central bank meet. None are expected to change policy.
The market has been aggressive in pricing in cuts starting early next year for the Fed, ECB, and SNB. The issue is how rigorously do officials push back against what the market has done. Of these G10 central banks, the market seems most suspicious of the Norges Bank, with the swaps market not convinced its tightening cycle is over. The Fed and ECB will update their economic forecasts, and these should be seen as part of their communication and forward guidance.
This week's FOMC meeting will likely highlight the big differences between where the Fed sees interest rates in 2024 and where the market sees rates. The November job report this past week highlights that the labor market remains healthy despite a slowdown in hiring and an unemployment rate that is trending higher.
But where rates head from here will largely depend on the economy, and it is clear from Powell's last speaking event before the FOMC blackout period that the Fed will let the data tell them where rates go next. Headline inflation has fallen, but core CPI has remained stubborn, and while it has come down, it has been a very slow progression. This means it will be difficult for the Fed at this stage in the game to forecast too many rate cuts in 2024.
Currently, the market sees rates at the end of 2024 around 4.35%, while the Fed was projecting an overnight rate of 5.1% at the end of 2024 based on its September Summary of Economic Projections. In other words, the market sees about 75 bps more rate cuts in 2024 than what the Fed is projecting.
The market is pricing in "Peak Fed”, with 79.7% certainty of at least 25 bps of cuts as early as May of 2024 and March a coin toss as to whether that is the first cut or not.
If the Fed is done hiking, we may indeed see yields peak, including on longer tenors, such as the 10-year note. Next week should certainly give us some clues with CPI, PPI, and the Fed’s meeting including the SEP report with their latest views on monetary policy.
As the Fed approaches their first cut, it’s important to consider that oftentimes that leads to downward pressure in US equities.
What's happened since the last Fed meeting in September?
- Financial conditions that had tightened significantly until the Fed's November meeting have since reversed. In fact, it's been the "largest easing in 40 years"
- CPI Inflation came in much lower than expected; PCE continues to decline smoothly, coming in lower than the Fed's year-end projections
- Inflation Expectations improved with the last reading this Friday declining to 3.1% from 4.5%
- The Unemployment Rate declined to 3.7% from 3.9% with this Friday's release
- ISMs and PMIs have shown marginal improvement
The question is whether the Fed embraces the victory over inflation and declares an end to their hiking cycle. We think they won't, “hawkish hold” is our main bet. We need to take from all of that is Chair Powell's last speech on Dec 1st, where he said:
“It would be premature to conclude with confidence that we have achieved a sufficiently restrictive stance, or to speculate on when policy might ease. We are prepared to tighten policy further if it becomes appropriate to do so.”
We've heard mixed views from Fed speakers over the last month, many of whom have expressed concerns about housing and services. They seem to think inflation risks are still skewed to the upside and the 2% target will only be achieved by the end of 2025.
We have marked up the Fed's September projections with the last readings we have on each of these indicators. The Real GDP is the last available annualized reading as of Sep 2023. As we can see, the last readings are much better than the Fed's projections. This is likely the reason, we're not going to see a hike in December and unless something extremely drastic happens with inflation, we're not likely to see another hike during this cycle.
Everyone will be watching the Fed’s rate cut projections. Last September, what sparked a market sell-off was the Fed lowering rate cut projections to only 0.50% for 2024. Traders were pricing in 1%-1.25% and the Fed themselves had the number at.
Now given that financial conditions have tightened and inflation is now well within their year-end target, the question will be; Will the Fed increase their rate cut projections?
We don’t see why they would have to. They’ve indicated that rate cuts are to begin after mid-2024 and if we go by that schedule, they have a meeting in March where they could change their projections. Holding the projections firm at this stage would allow them to keep that hawkish bias.
Assuming they don’t change the rate projections, a change to inflation and unemployment numbers could be just as telling. If the Fed lowers their inflation projections, that could signal additional cuts. And if unemployment projections are revised lower, that could possibly seal the deal on further cuts.
Unemployment remains low, but it’s a known phenomenon that the labor market tends to be strongest before a recession. And if the Fed is expecting substantially lower growth, that’s likely to be accompanied by higher unemployment. So this will still be something to monitor in the next few months.
Eurozone macro data
ECB Executive Board member Isabel Schnabel signaled a shift to a dovish stance in an interview with Reuters, saying, “The most recent inflation number has made a further rate increase rather unlikely.” Inflation has slowed sharply for three months in a row to just above the ECB’s 2% target. Schnabel, the first policy hawk to change her view, also warned (as have other policymakers) that the fight against inflation is not over and that prices may rise again as budget subsidies expire and high energy prices fall out of annual comparisons.
Meanwhile, Governing Council member Francois Villeroy de Galhau told a French newspaper that disinflation was happening more quickly than previously thought. “This is why, barring any shocks, there will not be any new rise in rates. The question of a rate cut could arise in 2024, but not right now,” he said.
The eurozone economy contracted slightly in the third quarter of 2023, pressurised by changing inventory levels, as well as weaker economic sentiment.
The third estimate for the quarter-on-quarter eurozone gross domestic product (GDP) growth rate for Q3 2023 came in on Thursday morning, clocking in at -0.1%. This was lower than Q2’s 0.1%, but was in line with analyst estimates. The third estimate for the year-on-year eurozone GDP also came in at 0%, quite a steep downturn from Q3 2022’s 0.6%, as well as analyst estimates of 0.1%.
German economy struggles
Industrial output fell for a fifth consecutive month in October, sliding 0.4% sequentially, which was more of a contraction than the 0.2% increase called for in one consensus estimate. Factory orders unexpectedly slumped, dropping 3.7%.
Meanwhile, the jobless rate rose to 5.9% in November, the highest level since May 2021.
Japan macro data
Comments by Bank of Japan (BoJ) officials stoked speculation that the central bank may abandon its policy of negative interest rates earlier than anticipated, weighing on riskier assets. Equities came under further pressure as data showed that Japan’s economy contracted by more than initially estimated in the third quarter of the year.
Amid perceived BoJ hawkishness, the yield on the 10-year Japanese government bond (JGB) rose to 0.77%, from 0.71% at the end of the previous week. A notably weaker-than-expected 30-year JGB auction was another factor that pushed yields higher. Growing speculation about BoJ policy normalization saw the yen strengthen to the low-144 level against the U.S. dollar, its highest in nearly four months, from about 146.8 at the end of the prior week. The Japanese currency also gained in anticipation of reduced interest rate differentials with the U.S.
Japan’s gross domestic product contracted by a bigger-than-estimated 2.9% on an annualized basis in the three months ended September, compared with an initial reading showing the economy had shrunk 2.1%. The downward revision was due to a larger drag from private inventories as well as slightly lower private consumption.
Japan's service activity expanded at the slowest pace in a year in November, weighed by an accelerating decline in new exports and softer demand, however, the outlook for the sector remained upbeat, a business survey showed on Tuesday. The service sector has been a bright spot for the world's third-largest economy, helping offset the drag to growth from struggling manufacturing. The final au Jibun Bank Service purchasing managers' index (PMI) slipped to 50.8 in November from 51.6 in October, according to index publisher S&P Global Intelligence.
Speculation grows about earlier-than-expected monetary policy shift
Comments by BoJ officials during the week were taken by some investors as suggesting that the central bank could be preparing for an earlier-than-expected shift in its ultra-accommodative monetary policy and that the removal of its negative interest rate policy could come soon after any potential lifting of the BoJ’s yield curve control policy.
One of the BoJ’s two deputy governors, Ryozo Himino, speaking hypothetically, said that Japan’s economy could benefit from an exit from ultra-loose monetary policy, as rising wages and prices would be favorable for households and firms. He nevertheless stressed that the BoJ should tread carefully.
Separately, BoJ Governor Kazuo Ueda stressed that the handling of monetary policy would get tougher in the new year, anticipating an even more challenging situation. He reiterated the importance of closely watching if a virtuous cycle of rising wages and prices becomes stronger.
BONUS: JPY dilemma, carry or carried out
The government of Japan is engaged in one massive $20 trillion carry trade. And while today everyone is talking about the BOJ hiking rates as soon as December in its attempts to normalize, it is impossible to understand the consequences of Japanese monetary policy normalization without analyzing what it means for this carry trade.
Here is the toxic dilemma faced by the Japanese central bank now that it has reached the end of the road: on one hand, if the Bank of Japan decides to tighten policy meaningfully, this trade will need to unwind. On the other, if the Bank of Japan drags its feet to keep the carry trade going, it will require higher and higher levels of financial repression but ultimately pose serious financial stability risks, including potentially a collapse in the yen.
Either option will have huge welfare and distributional consequences for the Japanese population: if the carry trade unwinds, wealthier and older households will pay the price of higher inflation via rising real rates; if the BoJ delays, younger and poorer households will pay the price via a decline in future real incomes.
The starting point are two excellent papers from the St Louis Fed and IMF, which consolidate the Japanese government’s balance sheet to include the central bank (BoJ), state-owned banks (namely, PostBank) and pension funds (namely, GPIF, the world's biggest pension fund). A consolidation of debt is crucial to understanding why Japan has not faced a debt crisis in recent decades given a public debt/GDP ratio of above 200% that continues to rise. It is also crucial to understanding what the impact of Bank of Japan tightening on the economy will be.
So what does the government’s consolidated balance sheet look like? Below we show the results from the St Louis Fed paper. On the liability side, the Japanese government is primarily funded in low yielding Japanese Government Bonds (JGBs) and even lower-cost bank reserves. Over the last ten years the BoJ has effectively swapped out half of the entire JGB stock with even cheaper cash which it created, now held by banks. On the asset side, the Japanese government mostly owns loans, for example via the Fiscal and Investment Loan Fund (FILF), and foreign assets, primarily via Japan’s largest pension fund (the GPIF). The Japanese government's net debt position of 120% of GDP when accounting for all of this is one reason why debt dynamics have not been as poor as what would seem at first sight.
A gross balance sheet value of around 500% GDP or $20 trillion, the Japanese government's balance sheet is, simply put, one giant carry trade. It goes at the crux of why it has been able to sustain ever-growing levels of nominal debt. The government is funding itself at very low real rates imposed by the BoJ on domestic depositors, while earning higher returns on foreign and domestic assets of much higher duration. As that return gap has been expanding, this has created extra fiscal space for the Japanese government. Crucially, one third of this funding is now effectively in overnight cash: if the central bank raises rates the government will have to start paying money to all the banks and the carry trade’s profitability will quickly start unwinding.
The first question that then arises is why hasn’t this carry trade blown up over the last few years given the huge sell-off in global fixed income? Everyone else has stopped out of carry trades, why hasn’t Japan?
The answer is simple: on the liability side the BoJ controls the government's cost of funding and this has been kept at zero (or indeed negative) despite rising inflation. On the asset side, the Japanese government has benefited from a massive depreciation in the yen which has raised the value of its foreign assets. Nowhere is this more evident than the GPIF, which has delivered cumulative returns in the last few years larger than the past two decades combined. The Japanese government has earned returns from both the FX and fixed income legs of the carry trade.
It is not only the Japanese government that has benefited, however. Falling real rates benefit every asset owner in Japan, predominantly older wealthy households. It is often claimed that an ageing population does well from low inflation. In fact, in Japan it is quite the opposite: older households have proven bigger beneficiaries of rising inflation via the de facto decrease in real rates and increase in value of the assets they own.
What will force this carry trade to unwind ?
The simple answer is sustained inflation. Consider what would happen if inflation required the Bank of Japan to hike rates: the liability side of the government balance sheet will take a huge hit via higher interest payments on bank reserves and a decline in the value of JGBs. The asset side will suffer via a rise in real rates and an appreciation of the yen that causes losses on net foreign assets and potentially domestic assets too. The wealthy, older households will take a similar hit too: their asset values will drop while the fiscal capacity of the government to fund pension entitlements will erode. On the flipside, the younger households will be better off. Not only would they earn more on their deposits, the real rate of return on their future stream of savings would rise too.
If Japan is indeed embarking on a new chapter of structurally higher inflation, however, the choices going forward are going to be far less easy. Adjusting to a higher inflation equilibrium will require rising real rates and greater fiscal consolidation, in turn more damaging to older and wealthier voters, unless the younger voters get taxed. While this adjustment can be delayed, it would be at the cost of even greater financial instability down the road, and a much weaker yen. The yen, in turn, can only embark on a sustained uptrend when the Japanese government, via BoJ rate hikes, is forced to unwind the world's last big surviving carry trade in the post-COVID world, one which has allowed Japan to enjoy a period of eerie social and political calm. Those days, however, are about to come to a thunderous end.
Japanese 10 year extending the move higher. The gap vs the US 10 year is getting very short term wide.
Summing up the widowmaker trade in a chart. Higher Japanese rates would change the global landscape, the BoJ has been providing liquidity to the global economy by buying bonds, which puts cash in the hands of Japanese investors who often invest it abroad. This flow of funds may eventually stop.
Borrowing in JPY and parking the money in the MXN has beaten the SPX big time over the past 2 years. There are a lot of implications on global risk from the latest developments in Japan. Making "easy money" just got harder.
Just a blip or something bigger in the making? Obviously the JPY action is spilling over to various currencies. Chart shows the DBCVIX (historical volatility index of the major G7 currencies) vs VIX.
China macro data
Moody’s cut its outlook for China’s government bonds to "negative" from "stable" on Tuesday, saying that the country’s debt-laden local governments and state firms posed downside risks to the economy. The ratings cut from the U.S. credit agency was the latest setback for financial markets in China, which is grappling with a yearslong property market downturn and flagging consumer and business confidence. In response, Beijing issued a flurry of pro-growth measures this year to shore up demand, although analysts say the measures have been insufficient to revive the economy.
Bearish sentiment about China’s longer-term outlook appeared to lead investors to look past the private Caixin/S&P Global survey of services activity, which rose to an above-forecast 51.5 in November from October’s 50.4. The gauge remained above the 50 threshold, indicating expansion for the 11th straight month and recorded its highest increase since August. The reading contrasted with the prior week’s official non manufacturing Purchasing Managers’ Index (PMI), which contracted for the first time in 12 months.
On the trade front, overseas exports rose an above-consensus 0.5% in November from a year earlier, reversing the 6.4% decline in October and marking the first increase in six months. However, imports unexpectedly fell by 0.6% in November, down from the 3% growth in October. The results were disappointing given the low base effect of China’s pandemic lockdowns in the prior-year period, which significantly weighed on activity.
Crypto News
=> BlackRock, the world's largest asset manager, has secured $100,000 in seed funding for its spot Bitcoin exchange-traded fund (ETF), according to a recent SEC filing. An undisclosed investor purchased 4,000 shares at $25.00 per share, acting as a statutory underwriter for the Seed Creation Baskets.
The filing also revealed BlackRock's plan to pay the sponsor's fee by borrowing Bitcoin or cash as trade credit on a short-term basis, avoiding a significant impact on BTC prices. With 13 spot BTC ETF applications awaiting SEC approval.
=> The SEC has announced that it will delay its decision on approving or disapproving the spot Ether exchange-traded fund (ETF) offered by Grayscale. The SEC will have until January 2024 to reach a decision or extend the deadline further.
This decision follows an appellate court order for the SEC to review Grayscale's Bitcoin ETF offering. The SEC has never approved a spot BTC or ETH ETF, but if it approves a spot BTC ETF, it may consider approving multiple firms' funds simultaneously.
=> Fidelity and the SEC recently held discussions regarding Fidelity's Wise Origin Bitcoin Trust ETF application. The meeting involved representatives from Cboe BZX Exchange, SEC personnel, and Fidelity representatives reviewing operational aspects of the proposed Bitcoin ETF.
Fidelity stressed the importance of allowing physical creation and redemption for efficient trading and secondary market pricing. This follows the SEC's previous rejection of Fidelity's spot Bitcoin ETF application in 2022. The ongoing meetings indicate heightened industry speculation about the approval timeline, with Hashdex anticipating a U.S. spot Bitcoin ETF by Q2 2024 and Bloomberg analysts suggesting potential approval on Jan. 10.
=> Spot Bitcoin ETF by Fidelity was listed on the Depository Trust & Clearing Corporation (DTCC) website under the FBTC ticker.
Latest ETF 19b-4 deadlines:
=> The House Committee on Energy and Commerce has approved the Deploying American Blockchains Act of 2023, directing the U.S. commerce secretary to enhance the country's competitiveness in blockchain technology.
The bill establishes a "Blockchain Deployment Program" and advisory committees, aiming to promote blockchain leadership, improve coordination for federal agencies, and assess their readiness for adopting the technology. While not as impactful as some other bills, it signifies a step toward preserving U.S. leadership in blockchain development. The bill now heads to the House for a vote and, if successful, requires Senate approval for final clearance.
=> Jamie Dimon, CEO of the largest bank in the United States, JPMorgan Chase, again raised disdain and criticism towards the crypto industry. At a recent Senate hearing, Dimon had only negative comments to issue, going so far as to tell the US government to crush crypto.
Dimon and the heads of six other large banks appeared at the December 6 hearing of the Senate Banking Committee on oversight of Wall Street firms. The CEOs of Wells Fargo, Bank of America, Citigroup, BNY Mellon, Goldman Sachs, State Street and Morgan Stanley were all present at the hearing.
Responding to questions posed by Massachusetts Senator Elizabeth Warren asking his opinion of why crypto could be an attractive tool for bad actors, the JPMorgan Chase CEO said he maintains his deep opposition to crypto and associated digital assets with “criminals,” “drug traffickers,” and tax evaders. In her line of questioning, Warren claimed North Korea funded much of its missile program using the “proceeds of crypto crime” and funds terror group Hamas.
Adding to his disapproval of the industry, Dimon made a poignant statement: “If I was the government, I’d close it down.”
=> Societe Generale’s euro stablecoin, the EUR CoinVertible, has started trading on the European cryptocurrency exchange Bitstamp.
=> Global financial technology firm Circle has collaborated with Nubank, a prominent digital financial platform, to expand the adoption of the US Dollar Coin (USDC) in the Brazilian market.
=> A federal judge has accepted the guilty plea of Binance CEO Changpeng Zhao to one count of Bank Secrecy Act violations. The plea was submitted alongside Binance's $4.3 billion settlement with US agencies. Judge Richard Jones has ordered Zhao to appear for sentencing in February 2024, where he faces up to 18 months in prison.
However, federal prosecutors have objected to allowing Zhao to leave the US, citing concerns about his potential flight risk. Zhao is currently released on a $175 million bond and is not permitted to travel to the UAE, where he resides.
=> Crypto exchange Binance withdrew its application for an Abu Dhabi license as the exchange reassessed its global structure amid global regulatory pressure.
=> Terraform Labs co-founder, Do Kwon, will be extradited to the United States to face criminal charges related to the collapse of Terraform Labs. Montenegro's Justice Minister, Andrej Milović, plans to grant the U.S. officials' request for extradition.
Kwon, who was arrested in Montenegro for using falsified travel documents, faces eight charges in the U.S., including commodities fraud and securities fraud. The collapse of Terraform Labs in May 2022 triggered a cryptocurrency market downturn. While facing officials in the U.S., there is a possibility that Kwon could still be charged in South Korea as well.
Cryptos: spot, derivatives and “on chain” metrics
This week, the global crypto market soared, surpassing $1.55 trillion in total market capitalization on December 5th. Bitcoin led the charge with a remarkable 14.5% weekly gain, reaching its highest level in 19 months. BTC is now the world’s ninth-largest tradable asset, surpassing Meta’s $814 billion capitalization.
However, the price of Bitcoin briefly fell below $41,000 on December 11th at 2:15 am UTC, following a sudden 6.5% drawdown from $43,357 to as low as $40,659 in a span of 20 minutes. The drawdown marks the largest single-day decline for Bitcoin in over a month, with the asset having grown more than 12% over the last 30 days.
Ether, the second-largest cryptocurrency by market cap, also declined abruptly, falling more than 8.9% in the same time frame. The price of ETH has since stabilized and is trading for $2,233, down 5.3% on the day.Other large-cap crypto assets, including BNB, XRP and Solana also posted losses.
According to data from CoinGlass, the brief drop caused more than $270 million worth of long positions to be liquidated. The decline also wiped out some $1.2 billion in open interest on BTC, which is currently sitting around $17.9 billion.
Gainers / Losers last 7 days, block size volume.
Bitcoin
Bitcoin fell early Monday, validating the caution signaled by the options and futures market last week. The 6% drop to $40,500 has cooled the overheated crypto perpetual futures market.
A high funding rate, typically greater than 0.10% (for eight hours), is taken to represent excess bullish leverage or overcrowding of long positions. According to data source Velo Data, funding rates for BTC, ETH and other major cryptocurrencies consistently tapped the 0.15% mark in the second half of last week, signifying an overheated leveraged market.
It's a sign overleveraged traders have been shaken out of the market. Funding rates or costs associated with leverage become a burden when the momentum stalls, forcing overleveraged traders to exit and causing a minor bullish/bearish hiccup. Largest longs liquidation in the last three months.
The market-wide decline in the notional open interest, or the dollar value locked in open crypto futures contracts, suggests the same. The drop wiped $1.2 billion in open interest, which currently sits at $17.50 billion.
Last week we warned the following:
“...The market after the great spike of late October has entered a dynamic of higher highs and higher lows, although tremendously overlapped and volatile, to finally reach the most relevant previous high volume node. We believe that at this point, the market is likely to take a break and consolidate gains during December while awaiting the next ETF decisions in January.
While the market has dilated the VPOC ($38600) of the previous value area, this has occurred over the weekend and in a completely climatic and derivatives-led mode. Derivatives metrics show a market in climax with open interest soaring and the highest Deribit funding rate in a long time. Funding rate APR spiked to 133% during the initial squeeze above $40000...”
Bitcoin 04/12/23 4h chart
Bitcoin 11/12/23 4h chart
The dilation of the previous VPOC at $38600 in a climatic mode has led to what we expected, sharp pullbacks to start the week. As seen in the chart above, the key for bulls is to stay above the previous VPOC of $38600 and above the minor VPOC of all this recent bullish impulse. Any move below this area would lead to further retracements towards the mayor VAL marked on the chart.
On a low time frame chart, the verticality and lack of market structure and auction gave us clear clues that the bullish move was entering the final climactic phase. Since last Tuesday the market entered the distribution phase leaving a very clear structure (marked in red in the lower charts). At the same time the delta on USDt futures showed how the whales (100k-1M trades, marked in purple) were selling the market on the way up.
Bitcoin 04/12/23 5 min chart
Bitcoin 11/12/23 5 min chart
In the short term, the key for bulls is to find strong buying response at the $41750 intermediate volume node. Note how in turn, the VWAP anchored in blue has acted as a last support. Our bias is that this dip will be bought, as it could not be otherwise in this market, but will not succeed, forming a break and test of the upper red structure with targets the large lower volume node at $37500.
On the other hand, if the bulls react in the $41750 zone, the big battle for the bulls to win is to conquer the upper volume node at $43800. Conquering this selling control would undoubtedly open the door to a continuation of the uptrend.
On Chain Metrics
What Data Changed Before The Price Correction?
- SSR hits a 2-year high
In essence, a high SSR(Stablecoin Supply Ratio) means that Bitcoin is perceived as having greater value compared to stablecoins, showing that market participants are placing higher value on Bitcoin.
- Mara Pool's Distribution
The decision to distribute part of its positions after a recent peak suggests a strategic caution, possibly aiming to optimize gains and reduce risks.
- 50%+ Circulating Bitcoin Supply in Profit
At every historical moment when this indicator has entered this field, it has signaled Distribution, either to a local top or a major top for Bitcoin. The last time such a scenario unfolded was when Bitcoin was scaling towards its all-time high, flirting with the $65,000 mark.
- Long Term Holders' Resistance
Despite the overall bullish sentiment, a significant subset remains underwater.
- The Bull-Bear Market Cycle Indicator: overheated bull phase for the first time since July and the Miner profit/loss sustainability: block reward growing much faster than mining difficulty.
Ethereum
Ethereum, the second largest cryptocurrency by market value, experienced a sudden decline today with the influence of Bitcoin, deleting long positions worth millions of dollars in a few minutes. The sudden price move, the biggest price swing for Ethereum in nearly two years, triggered a wave of liquidations on leveraged trading platforms where investors used borrowed funds to increase their returns. According to Bybt data, long positions worth more than $82 million were liquidated in the ETH market. The flash crash was likely caused by a combination of factors such as a liquidity crunch and a long squeeze.
The market has been experiencing rejection in the $1700 to $2100 zone. It has clearly been a sell initiative zone since August 2022. At the same time it is coincident with the VWAP anchored at all time highs.
The market has managed to break out of this sell zone, but now has to consolidate above it. The move at the week's start has not altered this approach, although it is time for the bulls to prevent the price from returning to the inside of the sell zone. The bulls must avoid a false breakout.
Ethereum 04/12/23 4h chart
Ethereum 2711/23 4h chart
The price of ETH has been positively impacted by the recent bullish momentum in the global crypto markets, fueled by Bitcoin’s surge above the $43,000 price region. ETH maintains a distinctive market position attributed to its extensive developer community, widespread adoption, and pivotal role in decentralized finance (defi) and various blockchain applications. Despite the current positive momentum, there are apprehensions regarding the potential influence of selling pressure from whales on the cryptocurrency’s price.
As ETH surpassed $2,300, ETH whales began to book profits.
Classic markets
A late rally helped the U.S. major indexes end flat to modestly higher for the week. The small-cap Russell 2000 Index outperformed the SP500 for the third time in the past four weeks, helping narrow its significant underperformance for the year-to-date period. Growth stocks built modestly on their lead over value shares, however. Within the SP500, energy stocks lagged as domestic oil prices fell below USD 70 per barrel for the first time since June.
The data on job openings, in particular, seemed to drive a continued decrease in long-term interest rates over much of the week, with the yield on the benchmark 10-year U.S. Treasury note hitting an intraday low of 4.10% on Thursday. Yields rebounded in the wake of the payrolls report, however.
European stocks appeared to receive a lift from expectations that central banks could cut interest rates next year due to slowing inflation and signs that European economies have been faltering. Major stock indexes rose as well. France’s CAC 40 Index climbed 2.46%, Germany’s DAX gained 2.21%, and Italy’s FTSE MIB added 1.59%. The UK’s FTSE 100 Index tacked on 0.33%.
The yield on the benchmark 10-year German bond slid toward its lowest levels so far this year. Italian government bond yields also declined. In the UK, the 10-year government bond yield fell to below 4% for the first time since mid-May on expectations that the Bank of England could start cutting borrowing costs by mid-2024.
The rally started at the end of October has been a 3-part move primarily due to a market in a net short gamma position, systematic flows, and volatility selling. These are primarily a function of flows and positioning and have nothing to do with improvement in the fundamental outlook for the economy or earnings growth. However, the rest of the market participants have fallen into the trap of chasing the price without buying anything other than the fear of missing out (FOMO).
This past 2 weeks we have started to see clear exhaustion of the Magma 7 and possible rotation into fixed income. Rates are de-stressing and the sectors most sensitive to them have experienced a great week and more specifically on Friday. However, we do not believe that the easing of rates experienced during the past week is solely due to easing inflationary pressures but to a clear discounting of contraction in economic activity. This could be a misleading interpretation of the market thinking that it is time for the Russel and Small Caps. The price forcibly justifies the narratives of a softlanding which we believe is impossible to achieve.
According to Goldman's prime book, the Magnificent 7 have been net sold in 15/17 past sessions. Cumulative net flow YTD is basically flat, having been as high as 50% this summer.
Continuing enthusiasm over the potential of generative artificial intelligence (AI) appeared to be one factor in boosting the growth indexes and the technology-heavy Nasdaq Composite. Shares of Google parent Alphabet rose over 5% on Thursday after the company revealed its new AI model, Gemini, which can process text, code, audio, images, and video and can be incorporated into mobile applications. Meanwhile, Advanced Micro Devices rose nearly 10% on the same day after it announced the launch of a new generation of AI chips. Earlier in the week, Apple once again eclipsed USD 3 trillion in market capitalization and moved back near its summer all-time highs.
Sentiment and exposure metrics: extreme readings, all in!!
US equities continue to defy gravity. Equities vs. bonds valuation model from Longview Economics is on strong sell (and has been since August). That is its first strong sell signal since pre GFC.
Low quality stuff has surged lately, beating the Nasdaq by miles over the past month, but note that the MEME ETF is now higher than the QQQ YTD as well. Most shorted still way lower than tech in 2023.
You should fear "exuberant" breadth. The percentage of SPX stocks trading above their 50 day moving average has exploded to the upside.
Praying for “Softlanding” of $1 Trillion basis trade. The basis trade is a relative value trade where hedge funds exploit the small price difference between cash Treasuries and futures contracts.
They "short", or sell the bond future, and go "long", or buy the cash bond. The trade is funded in overnight repo markets and highly leveraged. If the unwind is now underway, the question for authorities - and financial markets at large - is whether the $1 trillion position can be unwound in an orderly manner.
November was also the greatest easing in financial conditions that Goldman Sachs has ever tracked, a historic month to be sure. Will that prompt the Fed to look at policy projections more hawkishly for December’s SEP? We believe it’s something to consider as the market undid a lot of the work the Fed was happy to see.
November was also an exceptional month for bonds, one of the best ever. Those dropping rates gave equities room to the upside after months of rising rates adding to jitters in risk assets.
Retail sentiment also saw the greatest drop in bearish respondents since April of 2009. 14,5 years of data, and we have to go back all the way there to see anything that compares to this shift in sentiment.
This led to the overall AAII bulls vs bears survey registering the highest level since April of 2021. It feels good to be long and longs are adding, which does beg the question, at what point do we become lopsided?
Retail flows have also surged, with $7B of inflows over the previous week into equities, according to JP Morgan.
Hedge funds have near all-time high gross leverage. What could possibly go wrong with their crowded positions?
Underneath the surface of this market we have seen some distribution of Mag 7 positions by hedge funds, lightening up exposure as they degross their books, which have rather significant total leverage (280-285%).
CTAs have been increasingly adding to longs at a rather rapid pace, also helping to push up equities over the last several weeks, as these momentum trading funds had started rather short going into November. Global CTAs are now the most long equities in 8 years after buying more than $225 billion worth over the past month. The largest such inflows since 2014.
GS CTA Update
Over the next 1 week
Flat tape: Buy $14 billion (SPX $590 million)
Up tape: Buy $19 billion (Sell SPX $300 million)
Down tape: Sell $11 billion (Sell SPX $770 million)
Over the next 1 month
Flat tape: Buy $36 billion (Buy SPX $1 billion)
Up tape: Buy $56 billion (Sell SPX $3.51 billion)
Down tape: Sell $200 billion (Sell SPX $63 billion)
Key pivot levels for SPX
Short term: 4,440
Medium term: 4,392
Long term: 4,352
According to Goldman, the corporate blackout window begins this Monday, with the $5 billion daily VWAP machine going into hibernation until mid-January. If Friday's price action seemed mechanical, the above probably had a lot to do with it since buybacks stopped at 3 PM ET, which was exactly when the mechanical move ended. Without these supportive flows it will be interesting to see if the derivatives market alone can support these overbought indexes.
Options, Gamma, IV, SKEW
Realized and implied vol continues to collapse under the weight of the “Long-Gamma regime”. 10-day realized volatility in the S&P 500 has rolled over to very low levels, and the VIX has followed along. Hedges are cheap here 3-months forward in ATM SPX puts.
SPX vs MOVE (inverted) have traded in almost perfect tandem for months. Lately the gap has become extreme
“Volatility suppression regime” no longer only intoxicates risky assets but also credit markets, US high-yield bond spreads have fallen to the lowest since April 2022.
The cost of protection is near lows looking out five years due to low level of hedging and Volatility selling strategies. Extremes don’t last forever in markets.
Skew continues moving lower on an almost daily basis. Market is boring and the crowd is pricing downside risk "confidently”.
Gamma
Once we get past opex on Friday, 40 % of SP500 gamma will come off (mostly Call gamma), which could increase volatility in the market. The loss of gamma and the absence of the buybacks set the market up for more volatility, especially during multiple central bank meetings. The big central bank meeting will also be the BOJ, which will be next week. If the BOJ decides to move and come out of its negative interest rate policy, it will start strengthening the yen and moving it lower, which does put at risk stability because it would likely start the unwind of the carry of trade, and it is hard to measure just how much impact that would have.
There's a near record level of open interest in IWM calls as we approach OpEx
Gamma new all-time high: $10BN per 1% mov. Insane!
This whole "Long Gamma" Options Dealers thing, also means that Dealers are drowning in "long Vega" in this "realized volatility plummeting to zero" environment (SPX 10-day realized volatility at 4.6, a 2+ year low). Therefore, they are part of the larger "Short Vol" hedge flow as they attempt to offset the loss of PNL by having to sell more near maturity volatility as it declines.
The Call resistance level will continue to be sticky as we get closer to OpEx. Dealers are long calls and that will continue to make that level sticky as they hedge. Now that is the current positioning, but note that we have important data coming out this week that could change things.
The 4600 call wall remains the insurmountable wall, highlighting the gamma " vacuum" up to 4515 points. However, 4700 is starting to become an important one as well. So there is clearly strong flow coming into the market. That call gamma was added primarily after Friday’s rally.
A market in positive Gamma should find rejection at the upper call wall and a buying response at the lower call wall. Market makers buy the dips and sell the tops. However, It wouldn't take much of a move in the SP500 to shift the index back into negative gamma (Flip point slightly higher at 4550) and trigger the systematic flows to flip back from buyer to sellers, implied volatility to rise, and credit spreads to widen, to unwind much of, if not all of the rally off the October 2023 lows.
On the other hand, if the data and FOMC continue to support the risk on and vol suppression regime, the market could conquer 4600 and rotate the higher notional gamma strike to 4700. The market has been lacking catalysts for weeks stuck with the 4600 call wall, this week it has drivers to reverse this situation by taking advantage of Friday's OPEX, where gamma is at its highest as we approach expiration.
Market Comment
How the equity market and the media translate the FOMC meeting over the very short term is uncertain because, generally, a volatility crush occurs during the Fed press conference as the VIX drops, leading to rallies between 14:30 and 14:45 ET, distorting what is going on in rates and currency. While the very short-term is not the concern, it is likely to be the case that as the yield curve rises over the next several months, and the risk of a slowing economy from real rates being more than 2% positive starts to impact the economy, it seems more likely than not that stocks will suffer as they generally do when the yield curve steepens.
Stocks typically drop sharply as the yield curve crosses back above the zero bound after a long-inversion, which remains the longer-term risk at this point because as the back of the curve continues to normalize for the higher rate world, the front of the curve will eventually begin to reset for Fed rate cuts as risk for a potential recession rises as the full effects of the Fed tightening cycle really begin to be felt, whether the Fed is forecasting it at this point or not.
Going back to 1989, this yield curve inversion has already been among the longest at 518 days, tied for the inversion in 2008 and well beyond the inversion of 2000; the only longer inversion was the one in 1989.
The 2022/23 inversion has been significantly deeper and longer. Meanwhile, its current inversion of around -45 bps is more on par with the depths seen in prior inversions preceding recessions. If it becomes clear to the market that the Fed won't be cutting rates as aggressively as it has priced in, along with a higher long-run neutral rate, it should lead to rates on the back of the curve climbing. Moving towards the front of the curve, due to the term premium for longer-dated bonds, it begins to climb again.
Bear market rallies are notoriously violent and abrupt. And this last one was among the most violent and abrupt of them all. There is no greater risk situation in which the risk is not perceived. Although the reader may think that the November rally is due to a real show of buying strength, unfortunately this is not the case. It is not how far the market is able to go but how it has done it.
In terms of auction and market structure, November is the best example of an aberration. We are firm in our opinion that all this upside movement initiated at the end of October does not respond to a healthy and well auctioned market. The following chart shows how the volume profile for the month of November presents a disastrous auction, full of gaps and inefficiencies. We believe that sooner or later all of this will be fully repaired.
The market in a positive gamma regime and with a wild gamma exposure becomes thick and sluggish. Last week an attempted bearish imbalance of the red sloping structure threw a failure on this November VPOC. Predictably, the dips are bought in positive gamma. However, since it is the maximum gamma, it does not have much upside and clearly the market, based on price dynamics, is showing signs of a market top.
The market faces CPI and the FOMC with volatility on the floor and irresponsibly long. Everyone and their brother expects the Fed to pander to traders by telling the market what it wants to hear, and for stocks to continue to soar at a 5-10% monthly pace. It's probably time for the market to get a painful reality smack.
In our opinion, the degree of complacency and degeneration that equity markets have reached far exceeds previous situations. The market and its new dynamics led by the vol crunch seem to be trying to create their own reality where flows defeat macro. I am sorry to tell the reader that although this has been successful in the short term, the final outcome is going to be very abrupt and painful. Macro takes its time, does not lie and always arrives.
Again, the key for the week will be the November´s VPOC at 4562 points on the SP500 future coinciding with the SPX lower gamma call wall at 4515. If sellers manage to break through this zone, the market will enter a negative gamma regime and the minor upper structure marked in red will be solved as distributive.
ES_F 4h chart 05/12/23
ES_F 4h chart 11/12/23
