Recession Is Coming

The current pricing of the US Treasuries suggests that the market is almost sure of an imminent US recession. How does that affect crypto investors and traders?

Short-Term US Treasuries Rally

Short-term US Treasuries are normally very boring securities having low volatility. These bonds have no credit risk and only a small duration risk. However, recent macro volatility makes the securities anything but boring, as the banking crisis forced the market to abruptly reprice a future rates path. Recent daily moves of the 2-year US Treasuries were 2-3 times larger than during the coronavirus panic in March 2020.

Daily range of the 2-year US Treasuries yield (bp)

2-year US Treasuries staged a historic rally on the news of the banking crisis. 2-year Treasury yield had the biggest three-week decline in 35 years. The yield fell 108 bp over three weeks ending last Friday, its biggest decline for such a length of time since the period that ended on Nov. 6, 1987.

Ironically, speculators provided a near-perfect contrarian signal of a top of the 2-year yield, amassing the largest ever short positions just before the historic rally (or the historical plunge in terms of rates). That has hit macro-focused hedge funds hard with many of them reporting double-digit losses in March.

2-year US Treasuries yield and CFTC speculative positions in relevant futures

Curve Steepening

Longer-term US Treasuries were more sanguine to recent developments. These bond prices advanced too, but a yield decline was far smaller.

The yield on the 10-year Treasury dropped 58 bp over three weeks ending last Friday, the biggest three-week plunge since the period that ended on March 6, 2020. It was a big move, but it pales in comparison with the historic rally of the 2-year Treasuries. The yield on the 30-year Treasury was down just 24 basis points over three weeks ending last Friday. That was more like a typical change in prospects of lower inflation and/or lower economic growth.

30-year Treasury yield (%)

As a result, the yield curve steepened a lot, rapidly reducing its inversion. Historically, the fast steepening of the US Treasuries curve after a peak inversion has been a reliable indicator of an imminent recession in the US (shaded areas on the chart below represent recessions).

Spread between 10-year and 2-year Treasury yield (%)

There is a caveat. Every signal coming from the US Treasuries market is now weaker than usual because the extremely high implied volatility of the US Treasuries suggests the market is very unsure about current pricing. The current level of implied volatility is already higher than during the coronavirus pandemic. Historically, a volatility peak was usually during a recession and not before it. I wonder if we’ll see bond-implied volatility at an even higher level than now in the coming recession.

ICE BofA MOVE Index (implied volatility of the US Treasuries)

Recession and Crypto

As I wrote previously, crypto should be generally more resilient in a recession than 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. Let me cite the chart from my 2023 crypto outlook, showing that during the coronavirus recession, Bitcoin plummeted like stocks and other risk assets, but its decline was not particularly big given its usual volatility even when the stock market plunge was highly unusual in depth and speed.

Bitcoin (BTC/USD)

Reality has been even better than I had expected, as the actual effect of the recent macro volatility has been very positive for crypto so far. Bitcoin dipped in the first days of the current banking crisis, but swiftly recovered and rose to a new local high.

Nevertheless, in the short term, the curve steepening signal of an imminent recession should be treated as a warning sign of volatility ahead for crypto too.

Conclusion

The recent rally of the short-term US Treasuries sharply steepened the yield curve and partly reversed its near-record inversion. Historically such episodes have been a reliable indicator of an imminent recession in the US. That may be a warning sign of volatility ahead for risk assets and likely crypto too, but longer-term that means a looser monetary policy, which historically has been very positive for crypto.

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