Across financial assets there are new dynamics on prices and yields as the US Federal Reserve (the Fed) has moved from passively watching inflationary pressures building to economic prints of 8.3% annual inflation. Against this backdrop there is a war in the Ukraine and Covid lockdowns in major Chinese cities. In our opinion, the main force impacting all risky assets is the Fed’s race to deal with inflation and we see them as woefully behind the curve.
US CPI year-over-year
In order to address the rising inflation levels that have clearly moved well past transitory, the Fed has embarked on an aggressive path of increasing interest rates. Having already increased the influential fed funds rate by 75 bps (100 bps = 1.00%) at its last two meetings, the Fed has signalled to the market to expect more increases at future meetings.
As US rates rise, capital will flow into the US and strengthen the US dollar (USD). This has been evident in the Yen and the Euro. Our view is that the USD is the largest asset globally. Its recent strength means that anything priced in USD is falling – from bond prices to equities to commodities to bitcoin and cryptocurrencies.
The strengthening US dollar can be witnessed through the US Dollar Index (Ticker: DXY), which is an index that measures the value of the US dollar relative to a basket of foreign currencies, including Euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc. The 15% move higher in the US Dollar Index over the last year has been driven by expectations for higher rates and by a flight to safety in the face of geopolitical tensions around the globe.
The US dollar should revert to a weakening trend if rates return to a path lower to the zero-interest-rate boundary and this will occur if there is a U.S. recession or severe market crash or both. The US yield curve has inverted which is seen as an advanced signal of a recession. The next signal to watch is the unemployment rate against its 12 month moving average.
The digital asset market has not escaped the drawdown we’ve seen in other risky assets. The CF Diversified Large Cap Crypto Index which measures a basket of the largest and most liquid crypto currencies is down 49% year to date. Bitcoin which is the largest, oldest and widely seen as one of the safer crypto currencies has not avoided the market carnage with the CME CF Bitcoin Reference Rate Index down 36% year to date.
Crypto currency markets were further roiled this past week with an algorithmic stablecoin called Terra depegging from the USD$1 it was meant to maintain. From what we have seen this was an engineered attack, but no matter, our funds have no direct exposure to Terra, Luna nor Anchor. Part of the Terra/Luna defence was to have bitcoin reserves which may have been sold in haste causing the fall in bitcoin prices. Bitcoin is in a time period relative to its past halving where the price tends to move sideways as we move towards the next halving, which will be in May 2024. We are watching the markets closely and welcome questions from our investors.
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