The Breakdown - Sucker’s Rally or the Worst Is Over?

Starting point is 00:00:00 Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by nexus.i-o, chain aliasis, and FtX. And produced and distributed by CoinDesk. What's gone on, guys? It is Monday, August 1st, and today we are doing a bit of a July recap. Before we get into that, however, if you are enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to dig deeper into the conversation, come join us on the Breakers Discord. You can find a link in the show notes or go to bit.

Starting point is 00:00:43 com slash breakdown pod. Also, a disclosure as always. In addition to them being a sponsor of the show, I also work with FTX. Now, I don't always do a recap of every month, but sometimes I think it just makes sense. Some months are so full of details and trends that I think it's worth taking the time to view them in aggregate. And in some ways today is actually a look at not just July, but June and July, how they differed, how they were part of the same story, and where it leaves us going into August. The TLDR on July, I believe, was one, continued fallout from everything that happened in June in particular, but also two, glimpses of market resilience, or at least a need to shift tone, sentiment, and

Starting point is 00:01:32 So given that assessment of fallout from June, that's probably where we need to begin our story. Let's look at both of these months first in the context of market performance. June was the worst month ever for Bitcoin. During the month of June, Bitcoin fell 40%. The previous worst month for Bitcoin had been November 2018 when Bitcoin was down 37%. Q2 overall was the worst quarter ever for Bitcoin, with the asset down 56%. But, of course, it wasn't just Bitcoin and crypto. The S&P 500 also recorded its worst half in 52 years down more than 21%. Bitcoin Ethereum and many other crypto assets touched their bottom in June. For Bitcoin, that was around 17,500, and for Ethereum, it was around $880. That was the Sunday after we found out that Three Arrow's Capital was going to

Starting point is 00:02:29 require an emergency, quote-unquote, not cooperating hearing the following week, and just after Celsius's bankruptcy filing. In total, Ethereum fell 44% in June. So that's where we were in June, not a very good month and clearly a reason to be a little nervous going into July. July had a different market story, though. Ethereum began rallying hard following the announcement of a second successful TestNet merge on July 8th. That was followed by the announcement of a September 19th, soft date for the merge of Mainnet. Subsequent to that, we saw multiple days with 8% or more increases in the price of ETH. In total, in July, Ethereum finished the month up more than 60%, from a little over 1,000 to 1,700. Bitcoin was up 20% on the month from 19,000 or so to 23,400. The S&P 500 was

Starting point is 00:03:21 up 1% on the month, and NASDAQ was up 11% on the month. In total, July was the best month for a lot of these markets since the rally during the pandemic. In particular, worth noting that the time right around the FOMC meeting in July was very good for both crypto and traditional assets. The day of the FOMC meeting, Bitcoin was up 8.6% and Eath was up 15.7%. Now, of course, the question that we've been asking is how much these gains have been a real shift, some end to the bear, versus a bear market relief rally. Perhaps another way of looking at at it is a simple reversion to an appropriate local bottom after things got so bleak around the big catastrophic failures of the months before, including UST and Luna, Celsius, and Three Arrow's Capital.

Starting point is 00:04:09 Within that, there was also a question of how much these price gains in crypto specifically were driven by, A, a shift in macro attitudes versus B, a takeover of internal crypto narratives, specifically the eth-merge being in the driver's seat as related to crypto prices. For that, let's look at what happened with the Fed. Both months, June and July, saw 75 basis point hikes. June was a surprise 75 basis points that had to be guided up the week of the meeting. Remember, coming into the summer, the Fed had been signaling that they were going to raise by 50 basis points in June, 50 basis points in July, and then TBD in September.

Starting point is 00:04:47 However, June was also expecting to see a decrease in the rate of inflation from May's numbers, and that's not what we got. That surprised to the upside is why the Fed had to suggest to markets that they were going to go to 75 basis points with just a couple days to go before the FOMC meeting. July, on the other hand, after the June inflation print, had seen markets start to guess that the Fed would raise a full percentage point, aka 100 basis points. That's what the market was pricing going into the FOMC meeting last week.

Starting point is 00:05:17 So what happened then in these meetings? Well, June was the tough on inflation meeting, where the Fed really, really made sure that we knew that they were looking to be Little Volkers, aka people who would do what it takes to fight inflation versus Little Arthur Berns, aka people who took their foot off the break too soon and allowed their decade to become characterized by inflation. The interpretation of the July Fed meeting, meanwhile, was peak-fed hawkishnesses past. In other words, people interpreted everything that happened at the FOMC meeting last week as suggesting that we were at, near, or past even the peak

Starting point is 00:05:50 of the Fed being aggressive in its fight against inflation. In June, we got guidance from the Fed around what we were going to see next. Powell was giving unconvincing answers around his willingness to tip the economy into a recession. Meanwhile, in July, guidance was largely absent. As we discussed last week, we're in a new period where the Fed has said that they are not going to give this sort of forward guidance in the immediate term, that what they do next will be entirely shaped by the real data they see. Data on inflation first and foremost, but also data around other economic factors like jobs. Importantly, in the July meeting, the Fed also said that, quote,

Starting point is 00:06:29 we are now at levels broadly in line of our estimates with neutral interest rates, and after front-loading our hiking cycle until now, we will be much more data-dependent going forward. Indeed, the market had not really started to turn up until Jerome Powell utter those words, and that's where the market really started to rip. At the same time, in July, the recession question came more into view. We got our second quarter in a row of negative GDP growth.

Starting point is 00:06:55 And while the National Bureau of Economic Research, the group in the U.S. who actually labels recessions, uses a determination that is much more complex than that sort of rule-of-thumb recession measure, markets took this as confirmation that even if we're not in a recession yet, that's where we're headed, and that will, whether the Fed likes it or not, have impacts on how long they can remain hawkish.

Starting point is 00:07:16 Indeed, this is not concerning to Wall Street as much as the opposite. it. They believe that a recession is the type of thing that could force the Fed to shift course and make monetary policy more accommodative again. So basically, you had the Tradfai markets internalizing what they saw as two big signals, the Fed having achieved peak hawkishness and an oncoming recession. Now, of course, this is something we'll discuss throughout the day and probably going forward, we could be in the setup of a huge bull trap. All that would take is the Fed being more hawkish than people are interpreting, getting a still high inflation print, and hiking more aggressively than anticipated in September,

Starting point is 00:07:50 and or genuinely not caring about recession indicators that remain arguably mixed. But for now, this is the broad interpretation. What this meant in crypto was enough room for new internal narratives to move into the driver's seat, specifically the Ethereum merge. Now, one other interesting possibility that we explored last week about the shift to bullishness is that it might be out of necessity.

Starting point is 00:08:13 I've seen a number of market commentators speculate that with fund withdrawals coming up later this year, a fair bit of money out there feels like they have to make some long bets to try to catch the market flat-footed and outperform. The logic here is that staying in cash when your fund is down 25% already isn't going to convince people to keep managing their money with you.

Starting point is 00:08:33 And if you're down 25%, the risk of being down another 10% because you went long on a Hail Mary is a lot worse than the good of the upside of it working. In times like these, security of your assets should be your number one priority. If you want to offset risk as much as possible and still stay in crypto, you need a trusted partner by your side. Nexo is a security first company that manages risk by relying on

Starting point is 00:08:59 mechanisms such as over-collateralization, real-time auditing, and insurance on custodial assets. Learn more about Nexo's reliable business model and start your crypto journey at nexo.io. That's nexo.io. Eager to make more informed decisions around crypto, chainalysis is here to help. Chainalysis demystifies cryptocurrency by providing industry-leading compliance, market intelligence, and investigations support for all crypto assets. For organizations like Gemini, Crypto.com, and BlockFi. Gain unparalleled visibility and maximize your potential with the leading blockchain data platform

Starting point is 00:09:43 by visiting us now at Chainalysis.com Coindesk. The breakdown is sponsored by FTX US. FtXUS is the safe, regulated way to buy and sell Bitcoin and other digital assets, with up to 85% lower fees than competitors. There are no fixed minimum fees, no ACH transaction fees, and no withdrawal fees. One of the largest exchanges in the U.S. FTXUS is also the only leading exchange that supports both Ethereum and Solana NFTs. When you trade NFTs on FTCS, you pay no gas fees. FTX app today and use Referral Code Breakdown to support the show.

Starting point is 00:10:24 Now let's talk about some of the specific events of last month. I think we have to start with the Great Unwind, aka the fallout of all the things that happened in May and June. So going back to June, we knew that Contagion was still working through the system from Luna, but we didn't know yet who would get hit or how long it would take. By the middle of June, however, crypto lenders had started closing withdrawals. The block started reporting that Three Arrow's Capital had stopped communicating with creditors and was possibly insolvent, and no one knew how any of this would resolve. In other words,

Starting point is 00:10:54 in June, it was getting worse. What about July? July was sort of a lot of that playing out. We started the month with 3AC having liquidation ordered in a British Virgin Islands court. Suu and Kyle disappeared from Twitter and from Singapore. There was an emergency hearing in New York City with lawyers for creditors complaining that the Three Aros Capital founders were not cooperating, a counter-complaint from 3AC of liquidators missing the execution of Starkware warrants, and basically just a big mess. Celsius's problems also escalated. They went from saying they wouldn't declare bankruptcy to going into a restructuring process.

Starting point is 00:11:29 They paid down a ton of their defy loans, apparently to recover that collateral before going into that restructuring process, and they switched lawyers over to the same firm that was handling the Voyager bankruptcy. Now, we also learned last month that in the quarter before, Tesla had sold about 75% of its Bitcoin holdings for $396 million, recording a $106 million loss. It's important to note that Elon made clear this was about liquidity and Tesla's needs, not a condemnation of BTC. In fact, I've argued that Bitcoin being more liquid is part of what makes it such good collateral.

Starting point is 00:12:00 But it was still narrative fodder for confirming the crypto is going down sentiment. But still, all of that didn't change the fact that there was a subtle but clear sentiment shift. We weren't seeing new institutional failures. It was just the things that we knew about already playing out. What about in other aspects of crypto such as regulation? There were a few global things that happened. The end of June saw the finalization of texts for Mika in Europe. Paraguay got crypto regulation done and is now waiting on a presidential signing.

Starting point is 00:12:30 Brazil hit pause on crypto regulations to revisit them after the presidential election this year. And Russia banned payments in crypto, although this was far from the full ban that the Russian Central Bank had wanted. In the U.S., initially there was a lot of momentum on stablecoin regulation, but that now has been shut down for the August recess, and it seems fairly unlikely that we'll see much before the midterms. Probably the biggest thing that happened in the U.S. from a regulatory standpoint was the heightened tension between the SEC and the CFTC. The SEC's insider trading charges around a former Coinbase employee led a CFTC commissioner to release a statement about regulation by enforcement.

Starting point is 00:13:07 Seems like that is a story that is going to be part of the fall landscape as well. What about in the real economy in the macro sphere? Well, the housing market is finally cooling off on a combination of higher interest rates and recession fears. The cost of mortgages has gone up so people can't buy houses, but sellers are worried that it's going to get even worse, so they're listing more. U.S. home sale cancellations hit their highest point since April 2020. Current inventory of homes for sale hit its highest point since 2007, and in general,

Starting point is 00:13:33 it's a very confused real estate market. In foreign exchange, the euro and yen both hit multi-decade lows. Euro hit parity with the dollar on the 14th of July, which is the first time that has happened in 20 years. The yen hit 139 yen per USD on the same date, which is the lowest exchange rate since 1998. Throughout the month, oil has been falling as well. There were multiple single-day drops of greater than 8% during July, with narrative citing U.S. recession fears and an industrial slowdown in China. There's also the fact that the U.S. has been releasing oil through its Strategic Petroleum Reserve

Starting point is 00:14:05 throughout July, which is something that will continue into September. On the geopolitical front, in my opinion, the most significant new developments are around China. We're seeing the loudening of domestic banking crises in China, with protests in Hanan, mortgage boycotts on unfinished apartment complexes affecting more than 300 developments across 90 cities, and just this morning, news broke that Evergrand had failed to deliver debt restructuring as promised. Bloomberg is now reporting that Chinese banks may be facing up to $350 billion in losses from bad loans related to the collapsing property market. There is, of course, also Taiwan, which we'll discuss in just a second.

Starting point is 00:14:42 But where does this all leave us heading into August? Well, broadly speaking, there are sort of two positions right now. Suckers' Rally versus the worst is over. The Sucker's Rally position views a lot of the return of optimism that we've seen as either A, hopium not borne out by the economic reality, or B, a necessary face-saving bet, even if it doesn't have a lot of conviction. The worst is over folks are pointing to things like the idea that the Fed has reached peak hawkishness, and in this space specifically that crypto may be dealing with fallout but isn't going to see

Starting point is 00:15:09 more true new crises. At the end of June, it really wasn't possible yet to make a worst-is-over argument on either front. Now it is at least possible. Remember, what has been happening in crypto is de-leveraging. Leverage in the system unwinding, sometimes in quite painful ways, is a derisking event. And with some of that risk unwound, some participants are able to at least consider risk that they couldn't a month ago. The ETH-merge trade is the shixtaping. example right now of something that seems like a really obvious and easy trade that fund managers and traders don't want to have missed. That said, this doesn't mean that August will be full steam ahead. On a Fed level, there is the gamble that inflation stays elevated and the Fed starts advising

Starting point is 00:15:49 that they're going to be real hawkish come September. We saw a bit of that going into the opening this morning, as over the weekend, central bankers had really tried to reinforce the fact that we were going to have to stay diligent to bring inflation under control. In the crypto space, the merge narrative is getting a lot more murky. The discussion is starting to shift to the potential for chain forks, questions of defy breaking, which protocols will support ETH2 versus proof of work ETH, etc. Kevin from Galois Capital, one of the loudest people warning about Luna in the months leading up to that implosion is now digging in on the Ethereum community. Alex Kruger kind of speaks to both sides. He writes, yes, this is a bare market rally for now.

Starting point is 00:16:26 Thing is, if inflation comes down fast enough, which is feasible, and Europe's energy crisis is not exacerbated by a harsh winter, also feasible, this could end up being the beginning of a bull market. No one knows as of now. That's why probabilistic spectators are already long. My base case scenario is, as of now, this lasts at least until the end of August, and to go beyond that, we'll need help from August inflation data published in early September. Most important upcoming events in order. Number 1, September 22nd, FOMC. Number 2, September 13th, CPI. Number 3, August 25th, Jackson Hole. Number four, August 10th, CPI.

Starting point is 00:17:03 Expect markets to de-risk, i.e. sell off the days before each event if market is running hot into them. Then, of course, we have the infamous ETH merge around September 19th. Now, in a different thread, Kruger noted that one thing that could tank his assessment is if Nancy Pelosi actually decides to go to Taiwan. Current reporting suggests that although that trip is not on her official itinerary, that's exactly where she's headed. My guess is that this might be the subject of tomorrow's breakdown. But for now, that's where I see things, where the month was and where we are going into August.

Starting point is 00:17:36 The last note is that it's worth remembering that this is historically one of the lightest months for trading. Because there is less activity in the markets and less liquidity, small moves can be more exacerbated in terms of their impact on price, particularly in crypto. Which means, of course, that everything could look a lot more dramatic than perhaps it should. So there we are, friends. That was June and July. going into August. But of course, we don't know. And there are a lot of X factors that could change things. For now, I want to say thanks again to my sponsors, nex0.io, chain alysis and FTX for supporting the show. And thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace.

The Breakdown - Sucker’s Rally or the Worst Is Over?

There aren't comments yet for this episode. Click on any sentence in the transcript to leave a comment.