Interest Rate Faction’ and ‘Inflation Faction’ Contest: Weekly Market Review From TokenInsight
Table of Contents
The Sell-off of Risky Assets Triggered a Sharp Drop In the Market
The heightened likelihood of an early interest rate hike poses challenges for the crypto market. The Federal Reserve’s initiation of debt reduction, coupled with the robust recovery of the US economy, has considerably elevated the prospects of an advanced interest rate hike. Simultaneously, provisions in the new US infrastructure bill concerning crypto taxation have added to investor apprehensions, impacting confidence.
With the US dollar gaining strength amid positive economic data, the values of non-US dollar assets experienced significant depreciation. Cryptocurrencies emerged as the primary choice for investors to liquidate, leading to a more than 10% decline in mainstream cryptos this week. This downturn triggered a derivatives clearing scale exceeding $2 billion, contributing to a general increase in market volatility. BTC volatility rose by 18.9%, while ETH volatility surged by over 42%.
The prevailing influence of the “interest rate faction” in the crypto market has impacted market expectations, leading to substantial alterations in the term structure of futures premiums. The once notable premiums in recent futures have dissipated, with investors adopting a prudent stance toward the medium and long term, resulting in a flattened curve structure. However, compared to a while ago, the premium curve has overall shifted downward, signifying investor concerns about rising interest rates and their reluctance to pay a heightened premium for long-term uncertainty.
In the options market, both short and long-term perspectives witnessed the concentration of options skewness around the midline this week, signaling a diminishing market optimism.
Inflation Affects the Floor, While Interest Rates Determine the Ceiling
Regulatory actions significantly influenced the crypto market’s performance this week. The passage of the U.S. Infrastructure Act, entering the implementation phase, introduced high taxes on the crypto market, elevating cost expectations for investors involved in crypto holdings and related activities. Furthermore, the US Department of Justice sold $56 million worth of cryptos to compensate victims of cases linked to cryptocurrencies, adding pressure to the market. Countries like India and Russia are also intensifying crypto supervision efforts, contemplating restrictions on their payment functions and categorizing them as investment products. Enhanced regulatory frameworks for asset transactions are being considered to enforce these measures.
The market may be significantly influenced by the improvement in the economic situation. Positive economic data this week has led to concerns about inflation within the Federal Reserve, prompting a push for an expedited debt reduction process. Federal Reserve Board member Waller indicated that inflation conditions meet the criteria for interest rate hikes. Acknowledging market skepticism about the Federal Reserve’s ability to control inflation, he advocated for hastening the debt reduction, aiming to complete it by early April and commence interest rate hikes in the second quarter. Another member, Williams, shared a similar perspective, and Clarida, the Federal Reserve’s vice chairman, expressed support for expediting the debt reduction process.
Significantly, Waller labeled Bitcoin as “electronic gold” in his speech, categorizing it as a “safe-haven asset.” The Federal Reserve’s characterization implies that the performance of safe-haven assets, including Bitcoin, is strongly inversely correlated with interest rates. Given Bitcoin’s prominence in the crypto market, this assertion establishes an upper limit for the overall performance of the crypto market.
Global policymakers advocating for accommodative monetary policies, be it the European Central Bank’s approach to inflation, Japan’s substantial spending plan, or the US infrastructure plan, suggests an anticipated increase in liquidity in the system. This has bolstered optimism among crypto market bulls, and concerns about inflation have resurfaced due to these catalysts. It’s noteworthy that U.S. inflation expectations, as gauged by the 10-year break-even inflation rate of the St. Louis Federal Reserve, have also influenced recent U.S. Treasury bond yields. The sustained expectations of inflation play a crucial role in preventing a “destructive decline” in the crypto market, while investors’ risk aversion has supported the lower threshold of market performance.
Foreseeably, investors’ assessment of the influence of interest rates and inflation will persistently impact crypto performance. The endurance of the lower limit, supported by anti-inflation demand, hinges on the trajectory of economic data. Whether the lower limit will be breached in the future depends on sustained economic improvement capable of mitigating anti-inflation demand. The upcoming release of economic recovery-related performance data, including the annualized quarterly rate of real GDP in the United States, will provide clearer insights into the future trajectory of the crypto market.
