Last week the Fed reminded investors it will stop at nothing to tame down inflation. Their decision to increase interest rates by 75 Basis points to 3.25%, and hints at further hikes, sent U.S. bond yields, and the U.S. dollar soaring, causing havoc in foreign exchange markets and volatility in markets. In today’s dispatch we examine (1) how asset prices have reacted since the announcement, (2) why some assets have held up better than others, and (3) what we could expect for the weeks to come. 

How have asset prices reacted to the Fed’s decision:

The chart above tracks the performance of a select group of assets immediately after the Fed’s decision. A few highlights:

1. The U.S. Dollar index (green line) has been the clear winner since the decision. U.S. government bond interest rates are soaring, and all maturities are now in positive real territory. That is, the interest rate the bond pays, minus the expected inflation in that time period, is positive. This makes holding U.S. dollars much more attractive - and the Fed has signalled that these returns are only going to get better as they keep rising interest rates.
   
   
2. Sovereign currencies like the Great British Pound (-6%), the Euro (-2%), and the Canadian dollar (-2%) are crashing vs. the U.S. dollar, just to name a few. Investors are looking to sell their local currencies for U.S. dollars before the purchasing power of their local currencies drops even further as the Fed continues to raise interest rates.
   
   
3. Equity markets like the S&P 500 and the Dow Jones industrial average tested the lows set back in June - we’ll break down the drivers behind this move in the S&P 500 section. 
   
   
4. Even gold (denominated in U.S. dollars), is down more than -2% since the announcement. This is not surprising, as gold has a historical negative correlation with real yields in U.S. bonds, and these got much better last week. The reasoning here is that when real rates are positive, investors ditch gold for dollars as holding gold does not pay interest while they wait.

Which brings us to Bitcoin… which is the only asset on the chart other than the U.S. dollar displaying a positive performance since the decision. Here are a few hypothesis on why bitcoin is holding up better than the rest:

1. Bitcoin is a proxy for buying U.S. dollars in the emerging world. It has liquid peer-to-peer markets in most economies and can be sold for dollars quickly. In an environment where local currencies are depreciating fast, and people don’t have access to a U.S. dollar bank account, buying bitcoin can be a good alternative. The fact that it is readily available for purchase worldwide and can be transferred instantly could explain why bitcoin has benefited in this environment vs. gold.
   
   
2. As the U.S. exports its inflation by rising interest rates, wages and ultimately asset prices in foreign economies will also suffer. Think of it this way, if butter goes up 10% in dollar terms, and your local currency drops 20% vs. the dollar in the same year, you’ll be paying 32% more for butter! ($1.10 * 20% more). Foreign currencies are simply reacting to the fact that most central banks won’t be able to raise interest rates as much as the U.S. without breaking their economies. Governments can either choose to break their own economy, or let the U.S. dollar break their currency and remain in power. In other words, bitcoin has better U.S. dollar liquidity and stronger property rights than a lot of global assets in this environment.

If these hypotheses prove to be correct, this should lead to: 

(1) stronger volumes in bitcoin spot markets as more participants become active. Side note: higher liquidity typically leads to lower price volatility. 

(2) a growing number in daily active addresses and addresses holding a non-zero balance on the bitcoin network. 

(3) positive growth in the total supply and user count of U.S. dollar-pegged stablecoins. 

It has only been one week since the Fed decision, so on-chain stablecoin supply does not yet fully reflect the potential increase in demand. However, we will continue to track and report on the total supply and user count of stablecoins in the coming weeks and months.

Last week’s announcement by the Fed was in line with the expectations of many investors. What caught some market participants off guard was the Fed’s desire to keep rates high throughout 2023. While their desire to keep rates high is not necessarily a prediction, it sends a strong signal to the market that the much awaited “Fed pivot” to start cutting rates may take longer than expected. 

Markets sold off aggressively after the decision with the S&P 500 dropping 5% and the Dow Jones breaking below the June lows. 

The decision by the Fed reinforces the view we shared last week, which is that the Fed wants to keep the wealth effect “in check” by establishing an artificial ceiling on asset prices through its policies and statements. 

The sentiment was echoed by Goldman Sachs analysts who last week announced they were cutting their price target on the S&P 500 from 4,300 to 3,600. This 3,600 target is consistent with the Bank of America and Morgan Stanley analysts that we shared here weeks ago as well. We are starting to see some convergence on analyst estimates around the 3,600 range for the S&P 500. For context, that level is roughly 1% lower than where the S&P 500 is trading currently. In other words, this is more evidence of the “sideways chop until the end of the year” narrative.

Another data point that supports this narrative is the fact that last week investors purchased a record number of put options for the S&P 500. In other words, a record number of investors bought downside protection for their portfolios.

Why is this important? Because many investors have sold already in this environment, and a material amount of those that remain invested have bought downside protection for their portfolios. This means that there are not that many motivated sellers left, which could help asset prices hold up at current levels for the near term. 

Lastly, the fact that many analysts are converging on their S&P 500 targets at levels close to the current level of trading circa 3,600, means that investors could be motivated to buy significant dips in the market - hoping to realize the target price by the end of year. This could help keep the dips in the S&P 500 “shallow” until the end of the year.

Not surprisingly, gold prices have been taking a beating since the Fed decision, down -2.53% in U.S. dollar terms. As the interest rate of U.S. bonds increases and inflation drops, the real “risk-free” return of holding U.S. bonds provides an incentive for investors to drop gold in favour of the interest-paying greenback. Demand for the U.S. dollar surges, and so does its value relative to other assets and currencies.

The fact that gold is down in U.S. dollar terms does not mean it is not a good hedge against currency devaluation though. The chart above shows how gold prices denominated in Great British Pounds, Euros, Canadian dollars and Japanese yen have performed since the decision.  As we can see, gold in GBP terms has soared +3.72%. By maintaining the same gold ETF as our underlying asset, the moves in gold then reflect the relative changes in the value of the denomination currency during the time frame.

In other words, holding gold did shelter the value of portfolios denominated in GBP, EUR and CAD. However, it has been unable to outperform the mighty U.S. dollar.  

On the DeFi front, another week of generalized risk-off sentiment with FED aggressively tightening monetary policies and with the bond/FX markets all over the world in complete disorder. 

ETH closed the week in the negative territory against a very strong dollar (-2.97%) and with barely no changes against BTC (-0.16%). The DeFi Index surprisingly outperformed both BTC (+5.03%) and ETH (+4.81%) after weeks of very bad performance.

Despite the negative price action, ETH completes two weeks since the Merge successfully occurred. Core devs and main contributors are excited with the network's performance and stability:

Although Ethereum blockchain progresses in strengthening its stability and other key metrics, the total value locked from dapps / protocols are still bleeding lower - the DeFi ecosystem deleveraging continues followed by lower crypto prices (source by Defillama) and Ethereum still maintaining more than 57% dominance:

Checking the pulse of stablecoins market, we notice a different trend in terms of volume with figures practically stable since the post-Luna collapse around $150B:

Investors remain cautious with the uncertain macroeconomic environment and with the stablecoins ready to be deployed under better conditions

Still on the stablecoins segment - finally a positive output for the affected users of the $80M Rari exploit after a long-time debate. As covered in the BEC some weeks, Tribe DAO reached an agreement and voted to repay the algorithmic stablecoin users:

As confirmed by Joey's - Fei Protocol's founder, the DAO took months to reach consensus on the final decision that was far from "decentralized". The core contributors confirmed that nearly 13M FEI (currently trading at $0.97) were paid to the users and around 27M in DAI (currently trading at $1). 

In response to the criticism from community members, Joey confirmed that "only a few governance decisions remain now for the Tribe DAO over the next couple weeks".

A very unique and unprecedented week on global markets with several parallel developments affecting the DeFi space - and as usual we will keep you posted here!

Last week, Bitcoin mining hosting company Compute North filed for Chapter 11. The company owes more than $500 million to at least 200 creditors. 

"The survival of the fittest" is still in play when it comes to Bitcoin miners. A considerable number of Bitcoin mining companies are still looking for new sources of capital to finance their operations. The ones that had already over indebted their balance sheets, before the current crypto winter hit, now find themselves in a tough spot to secure additional capital.

In fact, new lending pools for Bitcoin miners continue to make the headlines. In an effort to support the mining industry's growth, Maple Finance has announced a new $300 million crypto lending pool for public and private miners.

As reported by Cointelegraph the "Underlying loans in the new lending pool would last for 12 to 18 months with interest rates of up to 20%. The loan would be secured by physical and intellectual assets owned by the borrower and could include Bitcoin mining rigs.

Contrastingly, some industry peers see this as an opportunity to secure distressed assets from troubled mining firms. Bitdeer announced today a $250 million fund that will be backed by family offices and venture capital firms. As Stephen Covey once said “If there’s one thing that’s certain in business, it’s uncertainty.” It is not a new practice during times of uncertainty for some players to buy others' fear.

This week is packed with Fed speeches, with over 13 public appearances from 11 different Fed officials - including 2 by Fed Chair Jerome Powell. Mr. Powell will be speaking at a Digital Currency event hosted by the Bank of France. His words will likely make headlines in the industry.  We will also get the Personal Consumption Expenditures Index reading, which is another inflation metric that the Fed tracks closely. 

There has also been increased activity among U.S. regulators around crypto regulation, with a proposed bill to regulate stablecoins making its way through congress. 

While other U.S. officials like ex CFTC Chairman Timothy Massad, argue that stablecoins could be regulated under existing legal frameworks without the need or delay of having to create a brand new legal framework. 

This conversation will likely get louder and eventually will culminate in some form of stablecoin regulation. The outcome should stand to benefit stablecoin operators that are highly compliant and transparent, like Circle and USDC. And it will also benefit the industry overall, by introducing protections and assurances that will make millions more people feel comfortable to interact with this new technology.

Here’s what you can expect for the week ahead:

Tuesday

06.15 AM EST - Fed Speech - Chicago Fed President Charles Evans

08.35 AM EST - Fed Speech - San Francisco Fed President Mary Daly

09.00 AM EST - S&P Case Shiller U.S. home price index

09.55 AM EST - Fed Speech - St. Louis Fed President Charles James Bullard

11.00 AM EST - Federal Reserve Chairman Jerome Powell participates in the Bank of France Digital Currency event

Wednesday

08.35 AM EST - Fed Speech - Atlanta Fed President Raphael Bostic

10.15 AM EST - Fed Speech - Fed Chair Jerome Powell 

11.00 AM EST - Fed Speech - Fed Governor Michelle Bowman

2.00 PM EST - Fed Speech - Chicago Fed President Charles Evans

Thursday

08.30 AM EST - U.S. Real Gross Domestic Product

09:30 AM EST - Fed Speech - St. Louis Fed President Charles James Bullard

Friday

08.30 PM - Personal Consumption Expenditures Index (Expected +0.1% month-over-month, +6.0% year-over-yer)

09.00 AM EST - Fed Speech - Fed Vice Chair Lael Brainard

11.00 AM EST - Fed Speech - Fed Governor Michelle Bowman speaks on Bank Supervision

12.30 PM EST - Fed Speech - Richmond Fed President Tom Barkin speaks on what’s driving inflation

04.15 PM EST - Fed Speech - New York Fed President John Williams speaks on financial stability

It's a big week coming up, and as always, we'll keep you posted on any relevant news throughout the week right here and from our Twitter account.