Market Update – BTFD(P)

This past week we have seen disruptions in the biggest global markets which nobody has witnessed before. Touché.

15 years ago on this same mid-March weekend, Bear Stearns went under and needed a bailout. Much closer to home, 3 years ago to the day yesterday, the Fed dropped rates to 0% and announced the first bazooka of $700bn in QE in response to the 2020 COVID lockdowns.

This week, the world’s most liquid markets – the large DM sovereign bond markets, have been trading like an Altcoin.

US Treasuries, which we have constantly looked to for directional signals, had an unheard of 12-sigma move. The 1-year yield, which sits at the front-end with minimal duration risk, fell a mind-blowing 127bp in just 5 trading days from last Thursday’s peak.

German Bunds as well, across the curve, moved the most on record in a single day yesterday! Even more than during COVID, the Euro debt crisis or the Subprime crisis.

Volatility indicators – from the MOVE bond volatility to VIX and V2X equity vol indexes also had their largest moves since the shock of COVID.

Yet just looking at the price of BTC and ETH, and their volatility markets, one can be forgiven for thinking that nothing this magnitude of sort had been happening.

TradFi vs Crypto

The trigger for this rates driven meltdown, was an old fashioned bank run that led to the first US bank failure since 2008, and the 2nd largest in US history.

However, there was nothing old fashioned about this run – which took place in just a single day, where $42bn of deposits were drained from the $209bn Silicon Valley bank (SVB)!

How such a drastic pace of withdrawals likely took place was VC funds phoning their portfolio companies to yank everything from SVB after fears of their solvency spread following their equity raise call.

Objectively speaking, looking across the aisle, it finally seems like well-regulated Tradfi is now getting a taste of what unregulated crypto has experienced time and again last year.

The same asset/liability mismatch, and marking of positions on the balance sheet have eerie parallels to the failures of many crypto institutions last year.

We wonder how a regulated bank marking a large chunk of securities that are mark-to-market down 30-40% at par under a “hold till maturity” balance sheet entry, barely accounting for liquidity provision, is any better than a crypto firm marking their balance sheet with fully dilluted and unvested portion of tokens.

Or how a bank not hedging its interest rate risk any different from an exchange or borrow/lend desk not hedging its funding risk.

Of course a large part of the problem is TradFi friends are not used to the speed at which liquidity moves in tech and crypto today, a speed at which the larger financial world will eventually experience as well.

And while Sunday’s emergency actions by the Fed stops short of QE, it still counts as a bailout for trading mismanagement.

Giving banks a year-long window to exchange as collateral any-and-all their loss making bond securities for a loan at par is akin to a wealthy father exchanging a new Ferrari for the mangled up one, each time his son crashes.

In contrast, the crypto industry has had to pick itself up and learn the hard way without any bailouts or discount windows. Having to independently deal with liquidity buffers, active position management, counterparties and more, this sets industry survivors on a path of strong growth regardless of the difficult times ahead.

What is feeling like the end of the world for TradFi, is probably like another day at the office for the crypto community.

Indeed Silvergate and Signature were the 2 most important banks for crypto – and the powerful SEN and Signet networks will be sorely missed. However there are alternatives, and any well-run crypto institution would have already hedged their banking risk, albeit with less convenience and speed than before.

Crypto has dealt with so many arguably more impactful crises in the past year that this one feels par for the course.

The resilience of BTC since shows that while its clear now that BTC is not an inflation hedge, it certainly is a hedge against monetary irresponsibility.

Together with flows out of stablecoins, the weekend’s “QE not QE” moves by the Fed drove BTC mempool transactions to the highest since 2017, when derivative markets were still practically non-existent.

So we have somewhat moved back to the days of BTC as a transactional instrument, and while we are still far from the “bearer asset” state globally, any further steps by the Fed in that dovish direction might very well set things off.

22 Mar FOMC 

Regardless, we are set up for a blockbuster FOMC next week.

As these events took place during the Fed’s blackout window, outside of another WSJ Timiraos leak, we will get to hear from Powell on the Fed’s perspective of this crisis, and more importantly, see from the Dots how they view it affecting policy.

Bank analysts are all over the place forecasting the FOMC from a week ago – when most had pencilled in a 50bp hike. Today there are banks like Nomura calling for a rate cut and end to QT, GS for a rate pause, and JPM for a 25bp hike, among others.

Ironically our view is that the best thing the FOMC can do to calm markets is a business as usual approach – raising rates 25bp and keeping the dots (which implies 1 more hike sometime this year).

Anything overly dovish would strike fear in markets that the Fed knows something more, while pausing would confuse the message on inflation.

In contrast to the market, we believe that their quick actions over the weekend was precisely to ringfence the problem, such that they can have a 2-pronged approach to tackling 2 issues – the financial stability one (through the new Bank Term Funding Program (BTFP), and the inflation one (through rate hikes).

In that regard, we hope Powell would stay the course next week rather than channel his best Arthur Burns flip-floppery – we all know what followed in the 1980s after that.

The fundamental difference today from the other dovish-shift parallels like 1998 LTCM and 2019 “long way from neutral” is that inflation is still 6% today, unlike the 1+% inflation in all 3 crises of the past.

Furthermore, the enormous melt-up witnessed post the 1998 75bp LTCM rate cut is something the Fed will certainly want to avoid this time with inflation at these levels.

Unlike the 2008 subprime crisis, we don’t believe this is a systemic issue yet – just a liquidity reshuffle from the small regional banks to the mega banks like JPM, Citi or BofA with amongst the lowest loan-to-deposit ratios of all.

The $110bn Signature and $209bn SVB might look big, but in a $23tn banking system, they can be effectively ringfenced.

We expect that the BTFP program will be enough to stem further bank runs, and at least quell market volatility until next week’s FOMC, allowing them to hike 25bp.

Additionally, the subsequent out-of-this-world rally in global DM bonds will only make the asset/liability marking on the books of liquidity-strapped financial institutions less painful.

Apart from market stability, two things we are watching before next week’s FOMC are:
1. Credit spreads – as this is the one thing that will sway the Fed dovishly
2. Amount taken up in BTFP – this data will be released weekly by Fed and show the size of the liquidity gap at regional banks

Having said that, we believe the contours of the next crisis have already formed.

Duration risk is always a painful one, and never more so than now when globally central banks have raised rates at the fastest pace in modern history!

Furthermore, these losses are hidden on the balance sheet and marked as par.

In any case, we expect that today’s ECB decision will be a precursor for the FOMC next week – central banks will be keeping up their fight against inflation while working separately on ringfencing troubled financial institutions.

As inadequate as they are, the ECB have a penchant for dealing with failed financial institutions, and hopefully will not cause another panic in the street as they typically do.

We will be back with a further FOMC preview and crypto market update next week. Look out for the next edition of Just Crypto #6 dropping at the end of this month where we will be going through our trading views and charts in detail.