MAGGIE LAKE: Hello, and welcome to the Real Vision Daily Briefing. It's Monday, January 10th, 2022. I'm Maggie Lake, here today with Alfonso Peccatiello, the author of The Macro Compass and Real Vision's Weston Nakamura. This is shaping up to be a volatile week, so we decided to pull in not one, but two of our best thinkers to help us all make sense of what is going on. Hello, gentlemen.
ALFONSO PECCATIELLO: Hey, Maggie.
MAGGIE LAKE: I'm so happy to be here today because it was a rough Monday specially if you were long risk assets. Tech stocks continued their march lower. The yield on the 10 Year got as high as 1.8%. And Bitcoin briefly dipped below 40,000. Before we jump in, a short time ago, Real Vision founder Raoul Pal shared his thoughts on some of the technicals that he thinks are contributing to the move in crypto. Let's have a listen.
RAOUL PAL: Well, interestingly, as you know, I thought that we were going to see a large rally in crypto in the back end of the year, that would have been playing out the historical patents from 2013 or 2017. But it didn't happen, and that took me by surprise. And that made me sit down and look at the market and figure out, okay, what the hell is going on here?
Why didn't it do it? Is this good news or bad news or indifferent? What is it? I broke apart the market, and I'm going to go through some of the charts in a minute. And I realized that the network growth had slowed down significantly. You see, what had happened is a huge amount of retailer come in 2020. Then in 2021, we start off the year with a lot of institutions coming in allocating capital.
And then what happened was we started to see the rise of inflation. As inflation picked up, wages didn't pick up as fast. And the marginal buyer of crypto, the marginal investor, the retail investor was sidelined. That kept the network growth slower. Then we saw China and the Chinese were essentially banning crypto, and a number of active wallet addresses collapsed.
What you've taken is an all-time high in wallet addresses had suddenly fallen by about a third as these Chinese participants had left the marketplace. And the network has yet to adapt because it hasn't gone back to a new all-time high. And I'll show you some charts on that in a bit. It's been one of the sideways years, now we've not really ever had one in crypto like this.
Now, ETH has been more bullishly biased and that's been driven by the burning of tokens by the 1559 changes that took place during the year. And that has kept it outperforming. We've seen things Solana, AVAX, Terra also doing similarly because they're earlier in the network. As people moved away from Ethereum, which is expensive, the NFTs and stuff that, where there's more high frequency volume, they move to these other protocols. The other protocols started exploding in price because the network has been used by Metcalfe's Law valuation and in addition, many of these have got burning too.
MAGGIE LAKE: Interesting stuff, just a little snippet there of Raoul's outlook. For the full interview, you can check it out on Real Vision Pro tie. Raoul brings up a really interesting point that that impacted the retail investor. We know they were big drivers on the upside both in crypto but also in some of the big tech names that we saw piling into those trades, really pushing especially the NASDAQ higher.
What do you think is going through their mind now? What happens to that market dynamic now that we're in this potentially more volatile higher interest rate environment?
ALFONSO PECCATIELLO: Maggie, I think the main message I want to bust across is that people are waking up to the fact that the Fed is going to tighten. Literally, they are going to tighten. If you ask people around three months ago, there were doubts, maybe a couple of hikes, maybe there's low tapering. Now, we're talking about four hikes. That's Goldman Sachs coming out today with a note talking about four hikes. It's pretty much consensus.
But they're also talking about quantitative tightening at this point. We went all the way from QE to tapering which is slowing down the pace of increase of the balance sheet to quantitative tightening, which is quite a thing. It means literally reducing the balance sheet. And as the average investor out there gets accustomed to that and also interest rates start to reprice higher, and I should add real interest rates start to reprice higher, valuations in the most high beta assets out there start to matter a lot, because your incremental increase in risk free real interest rates basically allows you to place money in a cash short-term risk-free alternative at a lesser punitive rate. And therefore, valuations that are always a relative matter tend to get hit.
And I guess that's just what's happening here. If you look at asset classes performance across the board, it's the high beta stuff, the stuff that is really sensitive to Federal Reserve interest rate cycle, very sensitive to real interest rates, that's the one which is getting hit the most here.
MAGGIE LAKE: Yeah. And it's worth pointing out. We have a class of investors who've never really seen this before. It's been a long time since we've been in this environment. And it's a big switch very quickly. Weston, how is this playing out internationally, especially now that we have a backdrop where we may have central banks moving at different speeds?
WESTON NAKAMURA: Yeah. Well, just to pick up on what you just said that we've never seen a class of investors who've seen higher rates before, this reminds me so much this is exactly what people say about my generation of millennials now sitting on trading desks, some of them now becoming managing directors and all that. You've never seen what a not QE market looks. Well, you've never seen a non-bull market in rates, either, so let's all just calm down about that.
On to the international thing, first of all, last week, or before the New Year started, basically, at the very end of December, I had a solo RVDB and I pointed out all of these different regions and their market holidays, and why that's important, because absent certain regions and players markets, that's going to affect markets. And I specifically pointed out that the absence of Japan, when everyone comes back in January, Japan-- Japan's a major buyer of US Treasurys so you might see yield spike on that Monday.
Well, they did. Then when markets reopened for Japan, they leveled off for that time being. They've obviously spiked since then, but what I said was those moves, let's not attribute all of that strictly to inflation, or whatever latest Omicron headline is, or whatever that may be. Today, Japan was closed again.
You are absent of the largest foreign creditor in US Treasurys, once again, in the markets, and you saw a significant movement in yields. Would yields have moved the same way if Japan had reopened? Who knows, but you are absent a large buyer, and I'm sure that that contributed as well. And the other day, Treasurys are just very much like any other asset. There's a FOMO thing.
The Japanese could also get caught up in selling because others are selling, others are buying, and not necessarily some fundamental thing, everyone's waiting to pull the trigger. I think that, generally, though, eyes are going to be on Powell confirmation in Congress and on CPI that are both coming at the same time. And I don't think that there's a lot of people that are either in their offices or actually put putting capital to work ahead of that. Heavy volumes on the equity side, but I don't think that there's too much on the rates side.
MAGGIE LAKE: Right. And we do have these two major events coming this week. We have a lot of questions coming in already. Keep putting them in, we're going to get to them. But Alf, this is such a big change in thinking and Weston, absolutely right to point out the millennial thing.
I often wonder if the more experience you have, the more it colors. What you think is going to happen because you're already running the end game instead of just watching the developments unfold. But Alf, is the market correctly pricing in what's happening with the Fed? Have they gotten too aggressive about this call?
ALFONSO PECCATIELLO: I just tweeted something before the Real Vision Daily Briefing, which basically said, Jamie Dimon came out and said the Fed needs to hike 25 times. He says this every time and rates need to be 5%, 10%, whatever. He has come out publicly. There will be many more hikes than four this year. Jeff Gundlach has come out saying that you need to be short the bond market. Goldman Sachs came out with four hikes and accelerated schedule for quantitative tightening.
Every strategist I know on the street, which I still talked to, is telling me that you need to be bearish rates. Real interest rates have already sold off 40 basis points in the beginning of the year, which maybe doesn't sound too much, but it's a quite large move in only 10 days. In standard deviation terms, it's pretty large. It's a large move. You see all of that, and you see that the front end of the Eurodollar curve is pricing about three and a half hikes from the Fed this year, Maggie.
It's basically almost fully pricing in four hikes, which seems to be a reasonable amount the Fed pull off this year. And everybody out there is already talking about quantitative tightening. As you and I are talking about it, and Weston, then it probably means that some of it is already priced in as well. I just said maybe it's time to lean long tactically bonds out here, but there will be different dynamics out there that impact different parts of the bond curve, which are also very important for different equity markets or for crypto.
If we look at the front end of the bond market, is the Eurodollar market wrong in pricing three and a half fixe easier? I said it before, and I will repeat it again, the Fed will tighten. They're looking at CPI at 7%, which will come down, but it will be still way above their mandate. They're looking at a very tight labor market. We have seen the last labor report and participation rate doesn't pick up.
The pie of labor supply is not expanding. But the job openings are still there, because the economy is still relatively strong. As a result, you got a pretty tight labor market. They're looking at November 2022 midterm elections, and there undoubtedly is some political pressure to make sure that real wages, as Raoul pointed out in this clip, real wages are negative, they need to turn up again to make sure that the consumer is able to effectively be the engine of the next growth phase, cyclical growth phase.
In order to do that, you need to control inflation first. And also, the risk reward for the Fed here not to act is pretty bad, if you ask me. They will tighten, which means probably the front end of the bond market is correctly assessing the possibilities here. But the long end of the bond market is telling us that this is quite-- well, it's going to be a tightening that is going to cost something to long term future growth, basically.
The long end of the bond market is having a very hard time in pricing regime change. I have one of the charts here, chart number three for this Real Vision Daily Briefing, that shows the very clear trend 30-year bond yields have been in America for the last, what is that? I think it's 30 years on the chart probably, even longer, 35 years. Since 1987, 30 Year bond yields have dropped from 9% to where they are now at 2%.
And you can see this very clear linear trendline that I depicted in orange at The Macro Compass newsletter that I write, and you can see, I pointed out sometimes the regime changes that we heard throughout the last 35 years. There's a very clear channel and then 30 Year bond yields tend to trade upswings and downswings around this channel. But the trend line is very clear, and it's downward trending.
And the last regime changes we have listened to, we're in 2010, where everybody told me that QE was inflationary, and therefore bond yields had to go up. That was the regime change. Of course, nothing happened there. 2013, we had taper tantrum. That was another regime change. Well, nothing happened again. And in 2018, everybody thought, Jamie Dimon included, that 30 Year bond yields should have been 6%.
They went to 3%. And of course, they followed back to the trendline. Is this a regime change? No, it's not. Is this a moment where the bond market especially at the front-end can cyclically price higher? Yes, it is because the Federal Reserve will tighten.
MAGGIE LAKE: And I think you're reminding us of the shorter-term situation against the longer more structural term story, it's so important. I think Weston, the question that keeps coming up now is can Bitcoin perform, recover in a rising interest rate environment, even if it's short term? Is a hawkish Fed bad for Bitcoin valuation? What are you looking at when you look at the Bitcoin chart here?
WESTON NAKAMURA: I certainly don't look at FOMC expectations. The reason why is because I don't think that Bitcoin traders are particularly concerned with that either way. It really is just based on flows, buys and sells, that aren't necessarily attached to something inflation. Of course, there are people that-- what happens is people that have a certain narrative, a reason for why they are long Bitcoin, why they hold it could be any number of reasons.
And when the price actually does look goes in the direction that you want it to, it validates whatever your insert the reason is. For me, the story of for Bitcoin for Q4 is it revolves around this ETF launch from BITO in the US. Basically, if you look at it from October, and I talked about this with Jim Bianco and Ash towards the end of the year, but we're at a very critical level right now.
And the reason is because around this BTC/USD 40,000-ish level and this is not exactly that, but that's around the point where you start this October rally up to these new highs, and then it's right back down to this breakeven level. Right now, anyone who was long from there, if they just held on, they're now looking at potentially having a negative P&L.
What happened was you have these CME futures Bitcoin futures backed ETFs. If you look at the second chart, you'll see this CFTC COT data, and this is a chart of Bitcoin futures and the launch of ProShares ETF, and you could see that there's a runoff right before leading into it, that was literally ProShares getting their ETF in order as well as frontrunning speculators, all that kind of thing,
And then it launched, and you have a lot of open interest opened at that point. This whole rally is artificial in my mind, because this is all just mechanical in order to make this ETF and for inflows and share creation, and all that kind of thing. In the next chart, you'll see this positioning on CFTC. This is actually open interest from the peak in November, and you can see open interest down 40% in CME futures.
In the next chart, you can see this is the positioning of the dealer community, which is an inverse reflection of the investor community. You could see open interest spikes and then falls alongside of the price. Next chart, this is the asset management community who got in late and at the peak, and they are now currently very long CME futures. You can see the percentage of open interest now went from single digits to now a third of open interest as asset managers.
They're long throughout this whole decline, and they're starting to shut their positions. Next chart, this is the ETF itself. This is BITO, this is their holdings. And what I've circled here is both the daily holdings as of yesterday and the CME's open interest position for January and February contracts. This is the two contracts that they hold. They hold about half of open interest. This one ETF holds about half of open interest in Bitcoin.
If BITO, the ETF, holds half of the open interest of CME Bitcoin and Bitcoin was responsible for that rally from the beginning of October into November and then down again, well, then you really need to look at this ETF, this is ground zero. That's how I look at it. It's just a mechanical thing. It's a launch and it got a lot of immediate initial inflows, fastest on record.
It's not really a story about inflation or anything like that. It's just a flow driven story. And this is the channel of flows that I've seen.
MAGGIE LAKE: If I'm understanding you correctly, I think people when they were looking at that chart and the decline, they were saying, oh, it trades a risk asset. That's why they're making the link with inflation. You're saying forget the pyramid part, just look at the 40, for all of that was fictional or flow driven based on the launch of the ETF. Now, watch that 40 level because that's where it would have been trading and that's what we need to pay attention to now to get a sense of where it's going forward. Is that fair summary of what you just said?
WESTON NAKAMURA: You said it better than I did. This is going to either be a floor. This could very well be bottom tick currently for 2022, who knows, or should it break clean, you can get significant downside. You're going to get buyers coming in but there's a lot of people who are sitting, still sitting on profits that would like to take those profits, that are happy to.
MAGGIE LAKE: I think both on the macro picture and on Bitcoin, it's so helpful to have that perspective. Let's dive in a little bit and people definitely asking very specific strategy questions because we are at this point where people are trying to figure out what to do with their portfolios. Either one, jump in, I think Weston, this might be one for you, but Alf, certainly feel free to jump in as well. Question from Marshall on The Exchange, should I move my stack into Tether and buy back in later? I have already lost all my gains plus 10%.
WESTON NAKAMURA: I don't know, because I'm not you, only you can make that decision. I don't know.
MAGGIE LAKE: It's this inflection point, isn't it? For both of you, though, that if people, if they rode this down and they're underwater, what do you do in that perspective regardless of the underlying asset? You have to understand your risk profile, I guess, right?
ALFONSO PECCATIELLO: Sorry, Weston. I would just say, to Marshall, I think this was his name. If the volatility swings and the drawdowns are more than you can stomach, then probably the sizing of your position was too large in the first place. Then in general, when that is the