Crypto Outlook in 2023
Short-term crypto performance may be dominated by Binance worries, but I see a powerful bullish factor sometime next year. In 2023 the US monetary policy cycle will probably turn, supporting global liquidity, including crypto.
Monetary Policy Turns
2023 is expected to be a year when the US monetary policy turns. After the very fast monetary tightening in 2022, the Federal Reserve is anticipated to reach a peak rate of this cycle and to start loosening the monetary policy in the second half of 2023. Current market pricing suggests a rate peak around May 2023 and lower rates thereafter. Inflation in the US has probably peaked already and is forecasted to rapidly decline in 2023, allowing the Fed to reduce rates, while an expected economic slowdown will make a case for the Fed to support the economy.
US core CPI (%)
There is considerable uncertainty regarding the timing of cuts since it’s not clear how the US economy will handle high rates and whether inflation will stick to higher-than-usual levels. A number of economists (notably big names Goldman Sachs and Citi) do not agree with the market pricing. Goldman Sachs in its macro-outlook for 2023 expects stronger-than-consensus US growth and no rate cuts in 2023. “The US should narrowly avoid recession as core PCE inflation slows from 5% now to 3% in late 2023 with a ½pp rise in the unemployment rate. To keep growth below potential amidst stronger real income growth, we now see the Fed hiking another 125bp to a peak of 5-5.25%. We don’t expect cuts in 2023” – Goldman Sachs says. But even Goldman Sachs (and Citi too) does not doubt that the rate will reach the highest point of this cycle in 2023, they just see the point as a plateau rather than a peak.
Ultimately, there is little doubt (even among hawks) that the Fed approaches the end of its tightening cycle and the policy rate will reach a cycle high sometime in 2023.
Global Liquidity to Improve
Looser monetary policy obviously means better liquidity, but this is particularly important in the current cycle. Fed tightening was very front-loaded in the current cycle, as market participants effectively reduced liquidity in anticipation of Fed actions. Forecasting higher short-term rates, market participants parked a lot of cash in the overnight reverse repo with the Fed, effectively taking that money off the market and the economy. The current size of the reverse repo facility is as much as 2.25 trillion dollars!
Overnight Reverse Repurchase Agreements (USD)
The Fed’s reaction to high inflation was delayed, but very strong, including jumbo-sized rate hikes and tough rhetoric against inflation. That made market participants wary of duration risk and promoted using the reverse repo facility, which has zero duration (because it’s overnight). No other market instrument with zero duration can support such a huge volume. Thus, a duration fear (which can be proxied by the implied volatility of the US Treasuries shown on the chart below) is a primary reason behind this year’s liquidity drought (and probably an asset prices plunge too). When the Fed rates will be close to a peak, market participants will be less focused on the upside potential of the rates and probably will start contemplating the downside potential of the rates. So, the duration fear will end (and maybe even reverse) at some point in 2023, releasing at least part of the reverse repo volume back to the market and the economy.
ICE BofA MOVE Index (implied volatility of the US Treasuries)
Recession Is Coming
Of course, there is a caveat. The monetary policy pivot is likely to be associated with an economic growth slowdown or a recession. The consensus forecast of the US economic growth is about 0.5% for the next year, implying a recession during 1-2 quarters of the year (probably in the second half) or something close to it. Also, there is a number of bond market signals and economic indicators suggesting a recession ahead. I particularly like the spread between 10-year and 3-month US Treasuries yield as a leading indicator of a recession. The chart below shows that the spread has indeed a very solid track record in predicting recessions.
Spread between 10-year and 3-month US Treasuries yield (%)
Shaded area represents recession
A recession is generally associated with stock market weakness and a broad risk-off. Given a crypto correlation with other risk assets, particularly technology stocks, that weakness may spread to crypto too. Moreover, a recession and a stock market drop often lead to credit events, which may hugely increase perceived counterparty risks, making banks and dealers reluctant to lend and reducing liquidity despite a looser monetary policy. Remember, modern money is actually credit money, and so a willingness to lend may be even more important that a central bank policy (at least in the short-term).
Still, I think crypto will be relatively resilient in such a scenario. Crypto may drop too, but its decline will likely be more measured compared with possible outsized stock market moves and other risk assets.
Unlike stocks, crypto has no fundamentals linking it to economic growth or decline, so it may not be influenced by an economic slowdown and a recession as much as stocks and other risk assets. For example, a stock may be slammed by downgrading a profit forecast because of the weaker expected performance of the underlying business. Moreover, if economic worsening affects mostly emerging market countries, that may even benefit crypto due to capital flight into crypto by residents of these countries.
For example, during the coronavirus recession Bitcoin plummeted like stocks and other risk assets, but its decline was not particularly big given its usual volatility, while the stock market plunge was highly unusual in depth and speed. 45-50% drop in Bitcoin in February-March 2020 was like a typical correction for Bitcoin, while a 35-40% plunge of the S&P 500 in less than 2 months had very few historical precedents. Bitcoin even failed to break the end-2018 lows in March 2020.
Bitcoin (BTC/USD)
Conclusion
The following year will mark a turning point in the US monetary policy cycle. The Fed tightening this year was a primary factor behind a drop in crypto as well as broader markets, and this trend may reverse in 2023. Specifics of the current cycle suggest that global liquidity may improve near a policy rate peak, likely supporting crypto prices. A possible recession is a threat, but crypto may be relatively resilient to it given the lack of dependence on the real economy.
Of course, if Binance fails, that will probably depress crypto prices even more, but I expect macro factors to dominate eventually. My bet is that crypto will be in a better position next year (at least compared with other risk assets).
*This communication is intended as strictly informational, and nothing herein constitutes an offer or a recommendation to buy, sell, or retain any specific product, security or investment, or to utilise or refrain from utilising any particular service. The use of the products and services referred to herein may be subject to certain limitations in specific jurisdictions. This communication does not constitute and shall under no circumstances be deemed to constitute investment advice. This communication is not intended to constitute a public offering of securities within the meaning of any applicable legislation.
