In addition to the new narrative in the crypto market, the US dollar monetary policy is a key factor affecting market trends. Especially after the ETF was passed and BTC and ETH gradually entered the asset layout of mainstream institutional investors, the market's capital structure, attributes, and investment methods are undergoing significant changes. Cryptocurrencies are increasingly forming a certain resonance or differentiation with other major asset classes such as US stocks, US bonds and gold.
In recent times, the market has repeatedly fluctuated between expectations of interest rate cuts, recession expectations, and election expectations. This essentially corresponds to the three factors of capital, fundamentals, and regulation, which are intertwined and influence each other. The most direct impact is the interest rate cut and the expectation of interest rate cuts. To some extent, in a small cycle, the expectation of interest rate cuts is more important in trading than the interest rate cut itself. Therefore, it is particularly important to sort out the upcoming interest rate cut in mid-to-late September.
1. Why the rate cut: Tightening is due to high inflation, but rate cuts are more due to a slowing labor market
Leverage differentiation under high inflation in the United States: the government increases leverage, residents deleverage, and support the resilience of the U.S. economy. There is not much disagreement in the market about the causes of high inflation. The core reason is the overly aggressive fiscal policy in the United States in recent years. While the aggressive fiscal policy has injected a large amount of liquidity into the market, on the one hand, the Federal Reserve has rapidly expanded its balance sheet, and the government deficit has increased significantly; but on the other hand, the debt of the household sector and the non-financial corporate sector has not increased significantly, but has improved.
Chart: The leverage ratios of the three major sectors in the United States diverge, and the household leverage ratio declines
The differentiation in leverage ratios further explains that although the yield spread between 10-year and 2-year U.S. Treasury bonds, which is a forward-looking indicator of recession, has been inverted since July 2022 and lasted for a total of 26 months, the longest in history, until August this year, when the labor market slowed down and expectations of interest rate cuts led to a decline in short-term interest rates, thereby resolving the inversion, the recession has not yet come.
Chart: This round of rate hikes has the longest inversion rate in history for U.S. Treasury bonds, exacerbating market concerns
The data does not support a recession, but the slowdown in the labor force and the deterioration of data quality have strengthened expectations for rate cuts and raised concerns about a recession. In terms of inflation, the current PCE (2.5%) and core PCE (2.6%) have not reached the Fed's target of 2%, but Wall Street traders generally expect the Fed to cut interest rates in September. In addition to Powell and Fed officials continuing to voice dovish sentiments to the market, another important background is that in the Fed's monetary policy framework in 2020, the original inflation target system was changed to an average inflation target system. At the same time, although employment and inflation are still the Fed's main dual goals of balance, employment and the labor market have been significantly prioritized. In other words, the Fed is more inclined to tolerate short-term high inflation to ensure the stability of the labor market.
The changes in the monetary framework are also further reflected in each FOMC meeting and the management of market expectations. Each release of data such as non-farm payrolls and unemployment rates will trigger repeated market fluctuations. Risk assets such as US stocks and cryptocurrencies are even more volatile. It is not an exaggeration to describe the current market as a panic. The market's high sensitivity, in addition to the expected range of interest rate cuts, is also superimposed with concerns about recession and concerns about the sustainability of AI narratives represented by Nvidia.
Judging from the data, the current US economy has not fallen into recession, but the slowdown rate has exceeded expectations and the quality of employment is not high. There have always been different opinions on the judgment of recession. The simple and effective indicator is the Sam rule, whose basic definition is that when the three-month moving average of the US unemployment rate rises by 0.5 percentage points or more from the low point of the past twelve months, it means that the United States has entered the early stage of economic recession. According to this indicator, the United States has entered a recession since July this year (the recession indicator under the Sam rule in July was 0.53%, and in August it was 0.57%), but mainstream institutions including the Federal Reserve do not believe that it has entered a recession.
Judging from the more authoritative NBER recession indicator, GDP, employment, industrial production, etc. have all experienced a small pullback, with the three-year pullback being less than 2%, far lower than the 5%-10% level in historical recessions.
Chart: NBER recession indicator is still far from recession range
The pressure of the slowdown in the labor market is even greater. The most critical indicator in the US employment data is the NFP data (non-farm payrolls), which is released by the Bureau of Labor Statistics (BLS) of the US Department of Labor. Looking at the sub-item data of the past three months, the manufacturing data is a big drag, mainly supported by the service industry and government departments. In addition, the US Department of Labor also revised down the previous data in August and September. The magnitude of the downward revision surprised the market. According to the revised data, from January 2024 to August 2024, the average increase in non-farm payrolls is only 149,000, significantly lower than the average of 175,000 in 2019.
Chart: Non-farm employment slowed down significantly in the past three months
Looking further at the types of employment, there is also a clear differentiation between full-time and part-time jobs. Full-time jobs in the United States continued to decrease both month-on-month and year-on-year, while part-time jobs increased both month-on-month and year-on-year. The increase in part-time jobs has to some extent masked the decline in total jobs, but it also reveals that the quality of employment data is not high.
Chart: Changes in the number of full-time and part-time employees in the United States suggest that the quality of employment data is not high
In terms of unemployment rate, the unemployment rate has risen to 4.3% while the labor force participation rate has remained unchanged, but it has fallen back, and the Sam's Rule index continues to rise. Among the unemployment rate data, it is particularly noteworthy that the U6 unemployment rate (a broader unemployment rate, close to the real unemployment rate of the entire market) has risen to 7.9%, the highest level since the epidemic. In addition, from the perspective of job vacancies, job vacancies have fallen beyond expectations, and the vacancy rate has also continued to decline.
Chart: JOTS non-farm job openings continue to decline
The cooling of the job market for two consecutive months coupled with the downward revision of previous employment data have greatly strengthened market expectations for interest rate cuts, with the focus only on 25bp/50bp ; on the other hand, concerns about a recession have begun to heat up.
2. How to reduce: The game between the market and the Federal Reserve, but data is still the key
After the release of the non-farm data on September 6, the market's performance vividly demonstrated the mixed data and the divergence of market consensus; risk assets rose and fell, but eventually fell. The August CPI data released on the evening of September 11 was released. Although it fell back to 2.5% year-on-year, lower than expected, the core CPI increased by 0.3% month-on-month, higher than market expectations. Overall, inflation continued the previous structural differentiation, with commodities, food, and energy continuing to fall, and services still having strong stickiness. After the data was released, the market's expectations for a 50bp interest rate cut were greatly reduced, and the stickiness of service inflation also indirectly indicated that there is no risk of recession at present.
Chart: July-August CPI data reveals that inflation stickiness is still high, and the rate of decline is slowing down.
The market's continued concerns about recession, coupled with the decline in inflation, have led to the market being very "tangled" about rate cuts, mainly because the current market consensus is inconsistent and full of contradictions. If the rate cut is 25bp, on the one hand, the pricing has been very sufficient, and the boost to risky assets is limited, but it also cannot completely reverse the market's concerns about recession; if the rate cut is 50bp, then the market's concerns about recession will increase significantly, which in turn will hinder the boost to risky assets. In either case, the direct impact on the market is that the sensitivity of risky assets will increase significantly.
From the Fed's perspective, in essence, its regulatory methods mainly include market expectation management and monetary policy management. The former relies on words, while the latter relies on real policy tools. At present, although the Fed has not actually cut interest rates, through the continuous external calls by a group of officials including Powell, the market has formed an expectation of easing. Both the U.S. Treasury yield and the credit interest rate in the U.S. domestic market have reacted in advance and formed a substantial easing.
Chart: US bank credit tightening ratio declines and credit spreads narrow
Taking the above chart as an example, the proportion of US bank loan tightening has been significantly reduced, and the credit risk spread has been declining since August 5, and the market easing trend is clear.
Based on the current slowing pace of inflation decline, the unexpected slowdown in the labor market and the substantial easing environment, the possibility of opening a 50bp rate cut on September 18th has begun to decline, and the probability of a preventive rate cut of 25bp has increased. Looking further, in the absence of clear data proving that a recession has arrived or that inflation has dropped significantly beyond expectations, a soft landing is still the baseline scenario for current transactions, and the market will continue to fluctuate amid data fluctuations on events such as recessions, rate cuts and elections.
3. What is the impact: Crypto risk appetite boosted, but adjustments are inevitable
Even though it is generally expected that the FOMC meeting on September 18 will start a rate cut cycle, risk assets will not necessarily show an immediate upward trend, especially since 2024, with the listing of Bitcoin and Ethereum ETFs in the United States and Hong Kong, the process of cryptocurrency compliance has not only allowed mainstream funds to start allocating crypto assets, but also further weakened the independent market of crypto assets. Crypto assets are greatly affected by the fluctuations of major asset classes such as U.S. stocks and U.S. bonds. In terms of the transmission of interest rate cuts, the direct impact is on the risk-free Treasury market, which in turn affects risky assets (MAGA7, Russell 2000, SP500, and crypto assets).
From a historical perspective, it is normal for asset volatility to increase during cyclical turning points, mainly due to the game of expectation gaps. If the market prices in advance, any changes in data will affect the pricing effect, and in turn affect the rise and fall of assets.
In terms of different types of interest rate cuts, past precautionary interest rate cuts usually result in risk assets reacting by first cutting and then bottoming out, and then resuming their rise (if it is a relief-style interest rate cut, there is usually a higher probability that assets will fall), and the bottoming out period usually takes one month.
Chart: When a precautionary rate cut is implemented, risk assets usually fall first and then rise
As for crypto assets, as high-risk assets, they are increasingly linked with the U.S. stock market. In the scenario where interest rate cuts are relatively certain and a soft landing is expected, the market's risk appetite should increase gradually. However, as analyzed in the previous article, the market is currently in a divergent stage before a new consensus is formed, and volatility is inevitable, whether it is U.S. stocks or crypto assets.
Chart: Crypto assets and US stocks fluctuate in the same direction
From a long-term perspective, the winning rate of crypto assets is still high, but in the next month, the volatility will still closely follow the US stock market and maintain volatility, especially before and after the implementation of the interest rate cut, the volatility may further increase. In addition, it is still worth paying attention to the impact of the US election. The result of the election directly affects the attitude of the government, including the SEC, towards cryptocurrencies, which will in turn have an impact on the market.
