The Breakdown - Volatility Ahead?

Episode Date: July 30, 2022

This episode is sponsored by Nexo.io, Chainalysis and FTX US. On this edition of the “Weekly Recap,” NLW looks at four reasons markets could see heightened volatility between now and November:  Fund managers making YOLO bets to avoid redemptions Inflation surprises shift the Fed back to hawkish Regulatory and media surprises for crypto  Politics and geopolitics  Nexo is a security-first platform where you can buy, exchange and borrow against your crypto. The company safeguards your crypto by relying on five key fundamentals including real-time auditing and insurance on custodial assets. Learn more at nexo.io. - Chainalysis is the blockchain data platform. We provide data, software, services and research to government agencies, exchanges, financial institutions and insurance and cybersecurity companies. Our data powers investigation, compliance and market intelligence software that has been used to solve some of the world’s most high-profile criminal cases. For more information, visit www.chainalysis.com. - FTX US is the safe, regulated way to buy Bitcoin, ETH, SOL and other digital assets. Trade crypto with up to 85% lower fees than top competitors and trade ETH and SOL NFTs with no gas fees and subsidized gas on withdrawals. Sign up at FTX.US today. - “The Breakdown” is written, produced by and features Nathaniel Whittemore aka NLW, with editing by Rob Mitchell and research by Scott Hill. Jared Schwartz is our executive producer and our theme music is “Countdown” by Neon Beach. The music you heard today behind our sponsors is “The Now” by Aaron Sprinkle. Image credit: Nuthawut Somsuk/Getty Images, modified by CoinDesk. Join the discussion at discord.gg/VrKRrfKCz8.

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.com, and ftX, and produced and distributed by CoinDesk. What's going on, guys? It is Saturday, July 30th, and that means it's time for the weekly 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 the link in the show notes or go to bit.ly slash breakdown pod. Also, a disclosure, as always, in addition to them being a sponsor of the show,

I also work with FTX. Now, the theme that I want to explore on this weekly recap and the lens that I want to view the events of the week through is the potential for more volatility ahead. Right now, markets are in the midst of a bare relief rally. At least that's what it appears like to me. Ryan Detrick, the chief market strategist at Carson Group, tweeted yesterday. As of now, the S&P 500 is up 3.8% on the day of the Fed hike yesterday and the following day today. Going back to 1970, Bloomberg data, this is the best two-day rally ever after a hike. Was the Fed hawkish, doveish? Bottom line is the market seems to be comfortable with it. Now, Bitcoin and Crypto are still in the green as well, Bitcoin above $24,000 at the time of this recording. Part of it may be an interpretation of the Fed

news this week, but part of it may also be that June was an especially bad month, and we needed some sort of reversion. June, you'll remember, was the worst month for Bitcoin ever in terms of price. The NASDAQ was also down significantly 8% on the month. July, on the other hand, is currently on track for the best month in a year for both Bitcoin and NASDAQ. BTC is up 35% off its bottom, while Eth is more than double its bottom right now. As we explore markets through the lens of potential volatility ahead, there was a really interesting thread from Cuppie, the author of the Adventures in Capitalism Blog. They write, as PMs, we all like to talk about global macro or individual stock picks. Long term, that's what drives price action. Short term, none of that matters. All that matters is

fund flows, redemptions, shortcovering, inflows, sector flows, etc. Look at 2022. Many large hedge funds are down 25% plus. Year-end redemption notices start November 1st. These guys have three months to turn it around or get redeemed. Everyone gets redemptions from time to time. Losing half your AUM because you are long Ponzi is existential to your career. Guys will fight like mad to make it back. This isn't about performance for performance sake. This is about survival. You have to get to flat or your business goes poof. Down 25% and it's poof anyway so you take a shot. If you guess wrong and Down 40%, you were dead anyway. Therefore, guys are forced to take shots on goal. Fix it by November 1st or lose the AUM. How do you fix it? Certainly not in cash. You can bet big on the short

side, maybe use options, but hard to put up big numbers that way. Instead, they're forced to play long-sided. Every data point shows that funds are massively underweight on long exposure. Huge cash positions, low gross, lower net exposure. These guys will all be forced to pivot long. Relative performance is cute when you're down five and market is down 25. It means nothing when down 20 versus 25. The FOMC will do its thing. Everyone will see a few hours or days of whipsaw action, but in the end, guys need exposure to save their careers.

They are going to have to buy it. Doesn't matter what Fed or economy or Dixie or rates or GDP does. Guys have three months to stack basis points. I think we get a sizable rally into the fall and sort it out from then. Guys just have to be long. As for me, I'm pretty damn long. Have highest exposure since the bottom in March 2020. Laid into GDP sensitive assets in late June.

Felt so confident that I'm on vacation. Good businesses haven't been this cheap except February 2009 and March 2020. Differences that those times were scary. Now isn't scary. We may have a recession. Shrug emoji, shrug emoji. Who cares about recession? You don't buy amazing companies for the next quarter or three.

You buy them because of long-term compounding. When they give away great businesses this cheap, you simply stack them and ignore the next question. They will eventually be valued on stabilized numbers. Ponzi was the last bubble. This cycle, guys need cash flow. Anyway, we all like to talk about stuff that makes us look smart, macro effects, single stocks, etc. That's fine and good. We don't talk enough about who's screwed and has 100 days to save his career.

Cornered animals do crazy things. Now, this strikes me as extremely interesting. The argument pretty clearly is that there is a small, small window for money managers to prove themselves before a withdrawal period begins, and sitting in cash ain't going to do it. Now take this and apply it to crypto. On Wednesday after the post-FOMC rally, Alex Kruger wrote, Today's upward move so large, crypto funds who missed it must now be praying for Amazon or Apple to report horrible earnings tomorrow or for a negative GDP print to load the dip. Hard for a crypto fund to explain to its LPs it missed the Ethereum merge trade because

of concerns about the macro. Now, of course, this isn't the only narrative about markets out there. Reuters wrote analysis, investors gauge U.S. stocks rebound, suckers rally, or market bottom. Zero hedge writes, Goldman explains why it's not buying this quote most hated rally. Benny Adler, a trader at Goldman Sachs, writes, in this tape, it currently takes a whole lot more bad news to make the market go down than it takes good news to make the market go up. So effectively, Adler and people like him are arguing that this is just pent up energy and hopium, which could be totally true. However, even if that is the case, in the short term, there's a lot of ways this could make things fairly weird. Remember, late summer, August in particular, is historically one of

the thinnest periods of liquidity. There's just less market activity happening. That means that even small moves can have outsized impact on prices, especially in an already shallower market like crypto. And especially, given that crypto is coming off a brutal period where there is just a lot of pent-up desire for narrative juice in the other direction. The point here is that even if this is a suckers' rally overall, the conditions may be such that it could look a little wild in crypto in the short term. But let's talk now about another factor that could increase volatility in both crypto and in stocks. That's the end of forward guidance. Forward guidance is basically the way the Fed has tried to get the market to do what it wants the outcome of monetary policy to be, even before it has to undertake

that monetary policy. Specifically, it's the process by which the Fed has told markets where it expected interest rates to end up at various points in the future. The Fed has been really explicit about this with their famous dot plots, for example, showing where different members of the Federal Reserve expect the federal funds rate to be at future meetings. This was a way of managing expectations, but it also brought with it some amount of constraint. Forward guidance doesn't strictly lock the Fed into doing what it said, but if actual Fed policy were to deviate meaningfully, it obviously undermines the credibility of that guidance and reduces the efficacy of that particular tool, as the markets would be naturally more skeptical of future forward guidance. On July 26th, the

day before the FOMC meeting, the Fed teased a shift away from forward guidance via Nick Timmeros, the Wall Street Journal reporter who is often seen as being effectively a direct line to Fed thinking. Nick wrote, some analysts question whether the cost of the Fed's forward guidance, which risks locking policymakers into a course of action they may later find unappealing, outweigh any benefits now because of high uncertainty over the inflation and rate outlook. 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 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 by visiting us now at Chainalysis.com slash coin desk. The breakdown is sponsored by FTX

U.S. FDXUS 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. FDX is also the only leading exchange that supports both Ethereum and Solana NFTs. When you trade NFTs on FTCX, you pay no gas fees. Download the FTCX app today and use Referral Code Breakdown to support the show. Traditionally, guidance has been used to ease policy, especially when interest rates are pinned at zero, and there's no room to ease by cutting further barring negative rates. But one innovation of the current cycle has been the use of guidance to tighten financial conditions. The argument in favor of providing guidance this year has been that the Fed was able to influence market-determined rates late last year, even though the first rate hike didn't occur until March. Powell at Central last month, quote,

people will look back on this period and say that we were able to have financial conditions tightened quite substantially, and we've only had three meetings at which we've only had three meetings at which we raised rates. Some say even though the Fed was wrong-footed by its guidance in June, the tool has been useful on net because it tamped down on large bond market swings. Others think precise steers from Powell at all after the last two FOMC meetings about upcoming moves are no longer helpful. Bill English, the former Monetary Affairs Director, said, if I had my druthers, I'd try to back away from giving basis point guidance for the next meeting or two, end quote. And that is ultimately exactly what we saw. The Fed basically said, look, from here on out, what we do is

going to be totally driven by data. John Ahern tweeted RIP forward guidance. We're entering the period where the Fed wants flexibility to get as close to the cliff as possible without being forced to lie to people. Peter Bukvar, the chief investment officer at Blakely Advisory Group, says the new forward guidance from the Fed should now be called, let's play it by ear, because they are now moving around in a pitch-black room with their hands out trying to feel something to hold onto that they can't yet see. A less cynical version comes from Harvard Professor Jason Furman, who writes Powell will and should, give no useful guidance about the Fed's September move because he doesn't know two months of job data, two months of inflation data, GDP data, the employment cost index, and much more.

If you think you heard forward guidance, even contingent, you heard wrong. Now, I'm totally for this. I think that overconfidence on the transitory nature of inflation is a big culprit for getting us into this mess and for locking the Fed into a rhetorical trap of their own making. But I also think that this creates the opportunity for more, not less volatility between now and September's FOMC meeting. Macro-Alph writes, ditching forward guidance ensures more volatility in Fed's policymaking and hence bond markets that requires higher, not lower, risk premium across asset classes. For all that the market is celebrating peak Fed hawkishness being potentially passed,

a higher than expected inflation print or a couple of those in a row could bring with it an ugly September surprise when it comes to that Fed hawkishness. So now we've discussed two types of possible volatility. market volatility stemming from traders making plays in a low or thin liquidity environment, perhaps driven by fear of missing out or fear of future redemptions, as well as the inherent risk of surprises that would push the Fed back hawkish in the absence of forward guidance. But now let's shift to another potential source of volatility, which is specific to the crypto industry. Let's call this one the regulatory or enforcement surprises.

On Tuesday, the New York Times published a fairly scathing report about Cracken's compliance with sanctions. It alleged that Cracken knowingly had Iranian users in violation of federal sanctions, that the Treasury Department had an open investigation into the exchange and was likely to issue a fine on the matter, but the reporting didn't include any details about the timeline for a fine or any confirmation of the matter from Treasury officials. The reporting seemed to be based on leaks of internal documents. Cracken was not for their part having it. They had a formal statement from their chief legal officer Marco Santorini that said they have robust compliance measures in place, closely monitors compliance with sanctions, la-da-y-da-y-da, but CEO Jesse Powell took to Reddit and

wrote his own response. These clowns wish they knew how to quit me. Unnamed but-hurt sources suspect that there's possibly an investigation from something that allegedly happened in 2019. The article is light on quotes and heavy on conjecture. Context of quotes is intentionally excluded because it doesn't fit the narrative. I'm flattered that they continue to sacrifice their integrity to get my attention, though. Now, outside of the colorful language, Jesse also just argued that this sort of thing is part and parcel of doing business in crypto. Quote, we're no stranger to regulation. We have excellent relationships with regulators and law enforcement around the world, and I can't remember the last time we were not involved in some investigation about something. Being

constantly audited and scrutinized as part of life as a heavily regulated licensed financial services. If anything, we are held to a much higher standard than legacy financial services. Basically, Jesse says that this is an MSM hit piece. And whether he's right or not, it's definitely the case that crypto firm is under investigation for X is kind of an easy headline right now. We've moved from the pro-crypto or at least excited about crypto phase during the bull market, to the crypto is definitely going to die phase as institutions were failing, to the, well, even if you survive, you still suck and here's all the people coming after you phase. I think we're in for more, not less of that, so buckle up.

Speaking of, we also heard this week that Coinbase is actually under SEC scrutiny around whether they listed securities. I already discussed this earlier in the week, but it's sort of worth noting in the context of this idea of investigations being a juicy MSM topic right now. These are prior investigations that have not as yet resulted in the SEC actually accusing Coinbase of everything, but the juicy headline absolutely destroyed coin in the markets this week. Even Kathy Wood sold millions of shares. In other words, these stories do have an impact right now. So that is our third potential source of volatility. But let's round out with our last potential source of volatility, and that is the

political and geopolitical. Let's speak domestic U.S. first. The end of the summer puts us in the last desperate final phase of the midterm cycle. Right now, Democrats look like they'll lose the House. With inflation high, the economy and general decline, the narrative and sentiment is against them. The question is, what can they do to pull out of their hat to get some Ws on the board before voters go to the polls? And more relevantly for our specific conversation, what might the potential implications for markets and or crypto B. As we've seen with past bills like the Infrastructure Act, crypto can randomly end up being collateral damage. There's nothing necessarily in the works right now that seems like it would affect us, but you never know. It is definitely the case that there are

machinations afoot for the Dems to try to pull off something interesting. This week, for example, they passed the Chips Act, including $52 billion in grants and incentives to the U.S. semiconductor industry to re-shore advanced chip manufacturing. There was also the surprise announcement of a slim-down version of the build-back better fiscal spending package, which is now called the Inflation Reduction Act. There's nothing crypto-specific in there, but it did contain a few unanticipated surprises, such as for fund managers, with the end of carried interest.

Macro-analyst Samantha LaDuke wrote, Biden's student loan forgiveness plus tariff cards yet to play, and about that timing. Fed has raised a full 200 basis points since May, while SPX traded sideways. And now Fed removes guidance at exact time, chips and BBB get resolved? Friendly reminder, it is an election year.

So will we see more surprises from the Biden administration in an attempt to shift the economic narrative going into the elections? Who knows? Then, of course, there is geopolitics. We talked a bunch earlier this week about the U.S. and China and growing tensions. And following the call between President Biden and President Xi Jinping on Thursday, the two leaders are now planning to meet in person as tensions over Taiwan intensify. Both sides describe the over two-hour call.

as a robust exchange on the disputes between the two largest economic powers in the world. Tariffs were discussed, but no resolution on the issue was reached. President Xi was quoted as saying those who will play with fire eventually get burned. I hope the U.S. side fully understands that regarding Speaker Pelosi's impending visit to Taiwan. And in a White House statement, the U.S. wrote, on Taiwan, President Biden underscored that the United States policy has not changed, and that the United States strongly opposes unilateral efforts to change the status quo or undermine peace and stability across the Taiwan straight. Richard Henania, the president at the Center for the Study of Partisanship and Ideology,

writes, ironically, on Pelosi going to Taiwan, it's funny how much of American foreign policy is just doing things that have no purpose other than to provoke more conflict. We might call each other petos and fascists, but one thing we can all agree on is going to the other side of the world and poking other countries so something bad might happen. In that case, we're all Americans. It's such a robust system because anything China does will be taken as confirmation it was right to provoke them. If they do nothing, then the policy is working. If China behaves aggressively, it proves that we were right to, quote, show strength. Anyway, I had to end on that note, because for a show about the potential for heightened volatility, nothing says volatility like

provoking armed confrontation with a nuclear power. Anyways, guys, I hope that your week was less volatile than what might be coming up, but for now, I want to say thanks again to my sponsors, nexus.com.com.com. And thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace.