Summary

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Markets wrapped up a volatile but positive first quarter as strength in tech was able to offset weakness in banks. Confidence has increased that the cyclical peak in bond yields is behind us. The bank turmoil likely pulled forward the end of the Fed's tightening campaign. Banking-contagion concerns have receded, though the coast is not yet clear. We'll monitor commercial real estate because we consider it an area of vulnerability.

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While the banking crisis is coming off a boil, the markets' attention will likely turn to the economic data to gauge the potential fallout from the stress in the banking system. The main transmission channel would be a tightening in lending conditions as banks focus on building liquidity. A possible decline in credit growth will potentially dampen economic growth and make a recession more likely, but also help bring inflation back to the Fed’s target sooner.

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With consumption the main engine of economic growth, a decline in confidence could have negative implications on spending behavior. Last week, markets found some relief that consumer confidence ticked up in March, not yet showing any negative reaction to the bank turmoil.

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Bitcoin faced volatility throughout the entire last week. It all started on Monday when the cryptocurrency fell by $1,500 in minutes after the US CFTC sued Binance and Changpeng Zhao. The bulls intercepted the move and pushed the asset north. This culminated in a price surge to above $29,000 on Thursday, but that was short-lived. A day later, BTC found itself dumping below $27,600.

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The European Union’s Markets in Crypto Assets Regulation, known as MiCA, will be the topic of an April 18 discussion in the European Parliament, heralding final formal agreement of the landmark law that will bring a crypto licensing regime across the bloc. MiCA was met with moderate optimism from the crypto sector. Despite some rigidities in the text regarding self-hosted wallets which have since been removed, the approach appeared as a reasonable and promising source of legitimacy for the space.

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We expect a quiet Easter on the macroeconomic front and on the crypto campaign by the U.S. authorities. It was quite an end to the quarter with the markets ripping higher and Nasdaq now closing over +20% above its 52-week lows. The media is calling this a bull market and there’s speculation that we may have entered a new bull market. But, there is still need for some caution here if we look at the macroeconomic environment and the market internals, which again show an overexcited market. 

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This Sunday it was announced that OPEC is cutting production by 1 million barrels. Geopolitical changes not seen in 50 years are continuing along with a market that lives in an unparalleled short-termism and is not able to value or interpret the depth of these changes.

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Macro and news

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USA February’s core PCE came in lower than markets had expected, a welcome relief after the month’s consumer price index, excluding food and energy prices, was higher than estimated.

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PCE 0.3% M/M, Exp. 0.3%

PCE 5.0% Y/Y, Exp. 5.1%

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Core PCE 0.3% M/M, Exp. 0.4%

Core PCE 4.6% Y/Y, Exp. 4.7%

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That’s good news for those worried about inflation and higher inflation rates. For technology companies, that’s more than good news, it’s music to their ears. Tech stocks benefit the most from lower interest rates, because their valuation tends to depend on future earnings, which are worth less when interest rates are high.

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The prospect of slower interest rate hikes, combined with investors’ perception of tech as a haven from the banking crisis, meant tech was a big winner in March. Investors are hoping April, historically a stellar month for markets, will be strong again this year. The March jobs report, coming out this Friday, will put that trend to the test.

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OPEC+ announced Sunday a surprise oil production cut of around 1.16 million barrels per day, starting in May. Analysts said the lower output could increase oil prices by $10 per barrel; WTI Crude jumped 7.16% to $81.09 as of this newsletter’s publication time. All this comes with U.S. strategic oil reserves completely depleted.

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Eurozone inflation cools significantly to 6.9% YoY in March, down from 8.5% in Feb and lowest level since Feb2022, but core inflation is refusing to slow.

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German retail sales adjusted for inflation now in a sustained drawdown on par with the Great Financial Crisis and the Eurozone Debt Crisis. We are still hearing from the authorities: "The economy is strong".

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Banking Crisis:

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The face of global finance is changing in a way that distorts returns on investment. Recent government and central bank interventions to shore up failing commercial banking systems (sparked by rising interest rates) has created a whole new politicized credit system.

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The developed world is grossly over-leveraged, a fact once considered only of academic interest because, it was thought, interest rates would remain low forever. With interest rates now rising, we’ve seen the collapse of three U.S. banks (Silicon Valley Bank, Silvergate Bank and Signature Bank) and the Swiss government assisted rescue of Credit Suisse Group.

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Other U.S. regional banks, such as First Republic Bank, are in distress due to excessive levels of deposit flight. Such distress in the banking system has echoes of the prelude to the global financial crisis of 2007-2009 and investors are rightly concerned that we stand on the eve of a similar event.

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What is important about the growing banking crisis, however, is how it is being tackled by central banks and governments. Their reaction to the distress will be the key driver for the path of economic growth, inflation and also returns for savers for many years to come

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More signs of bank stabilization during last week. Banks lowered their borrowings from the Fed's discount window while slightly boosting borrowings from the new term loan facility. The Fed's balance sheet is starting to shrink again.

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Borrowing at the Fed's discount window fell $22.1 billion for the week ending Wednesday to $88.2 billion.

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Borrowing at the new Bank Term Funding Program rose $10.7 billion to $64.4 billion.

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Borrowing at the foreign repo facility fell to $55 billion from $60 billion previously.

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The flight of deposits from small banks to large banks is noteworthy.

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Deposit flight is certainly an important risk. Many regional banks will have to cut lending to families and businesses as deposits shrink, but in the United States bank loans are less than 19% of corporate credit according to the IMF, while in the euro area it is more than 80%. What could generate a credit crunch is the destruction of capital in the asset base of most lenders. Credit standards have tightened significantly already, and the credit impulse of the economy, both in the US and euro area, has deteriorated rapidly, according to the respective Bloomberg indices. Both are below the March 2021 low.

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Even if we assume a modest impact on banks’ balance sheets, the combination of higher rates, declining optimism about the economy and the slump in equity, private investments and bond valuations is going to inevitably lead to a  crunch in access to credit and financing. This new financial crisis does not arise suddenly and it is not a is not a one day story, it is part of a cycle that has its genesis in the monetary expansion and financial repression imposed by the Central Banks with their policies of free money in infinite quantities for almost 15 years.

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Systemic credit event now overtakers “inflation stays high” as the biggest tail risk.

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However, the market assumes that high yield or junk bonds will not pose a risk as has happened in other crises.

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Crypto News

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Despite Binance’s KYC rumors and eventual US CFTC lawsuit last week, Bitcoin and other leading cryptocurrencies managed to remain stable in the following days. However, the collapse of Silvergate’s SEN instant transfer network as well as Signature’s Signet network in March can still show its claws, affecting the liquidity risk of overall cryptos.  

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The global movement towards de-dollarization is picking up. Last week in New Delhi, Russian Deputy Chairman of the State Duma Alexander Babakov suggested that Russia and India could launch a common currency and even include China in the initiative. Brazilian media suggested that the common currency could be a BRICS-wide effort, implying additional participation from Brazil and South Africa. The bloc could launch its own currency as a way of shifting away from the dollar’s dominance.

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And let us not forget, in December 2022, China met with the Gulf Cooperation Council (GCC), and launched what is effectively a “petro-yuan”, with a futures contract allowing for easy convertibility into physical gold. A weaker US dollar strengthens the appeal of crypto that has historically had an inverse relationship with the currency.

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NYU professor Nouriel Roubini authored a piece published on Friday MarketWatch warning that hundreds of US banks are “fully insolvent” and most are on the brink of insolvency. Roubini wrote that unrealized losses in the US banking system amounts to $1.75 trillion, roughly 80% of their capital. Unrealized losses are exactly that: unrealized. But “[if] depositors flee, the deposit franchise evaporates, and the unrealized losses on securities become realized. Bankruptcy then becomes unavoidable”.

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Cryptocurrency exchange Bittrex has announced that it will shut down its US operations due to “continued regulatory uncertainty”. Bittrex co-founder and CEO Richie Lai authored an advisory piece on the Bittrex website assuring customers that their funds were safe and sound, ready for withdrawal until April 30th.

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GLASSNODE’s report for this week noted net inflows of bitcoins to exchanges of 4.18K: the highest since the aftermath of May 2022’s LUNA implosion. GLASSNODE concludes that investors are realizing profits with the recent price surge and that the vast majority of inflows (almost 93%) are from short-term holders (STH), 65% of the coins in profit.

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Markets in Crypto-Assets (MiCA) regulation is coming to Europe with a new framework of EU-wide crypto rules that have been approved by the European Commission. The new system is not expected to come into force until 2024, but the EU aims to close the regulatory gap that exists between the crypto industry and existing financial services. MiCA has been tabled for an April 18 discussion in the European Parliament, heralding final formal agreement of the landmark law that brings in a crypto licensing regime across the bloc.

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What happens from here in Europe may provide indicators as to what will be implemented later in the US and other regions, this will undoubtedly be good for the sector, giving clarity and legitimacy to the sector. The legislation offers crypto companies such as wallets and exchanges a license for operating across the block in exchange for meeting governance and consumer-protection norms, and also introduces reserve requirements for stablecoins. The MiCA debate will be followed by discussions on another law known as the transfer-of-funds regulation, which controversially requires crypto providers to verify customers’ identity and which was also provisionally agreed back to in June 2022.

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Cryptos: spot, derivatives and “on chain” metrics

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Bitcoin has been stuck in the $26500 and $29000 range for almost 3 weeks and with clearly decreasing volume.

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Following previous analysis, the test to the VWAPS has provoked enough buying initiative to conquer again the high volume node of $23000. Once this level was conquered, the market went on to break the local highs with an astonishing and at the same time dangerous verticality. We have been consolidating for more than 3 weeks in this $27000-29000 zone. We believe that retractions to lower zones are necessary to unload leverage and as an effective unbalancing process of the marked value area.It should be noted that the movement has reached the third standard deviation of the VWAP anchored at the FTX event low in a movement that in our opinion is too vertical.  

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Bitcoin 27/03/23

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Bitcoin 03/04/23

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It is clear that this area of value is under demand control, it is now where buyers must demonstrate that this structure will imbalance in favor of demand. The effective imbalance of a value area is always the most delicate moment.It is necessary to contextualize this value area with higher time frame charts, it is certainly a key moment for bitcoin.

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As we can see in the previous chart, we are in an important confluence zone; VWAP anchored from highs and VWAP anchored from 2020 lows .We consider it absolutely necessary for a consistent bullish scenario that demand manages to break these VWAPS and consolidate above them. 

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The upper major value area is trying to unbalance, it is still very uncertain if the market is going to offer us a bearish unbalance failure and end of the bear market or if it is a break and test below this value area. Undoubtedly, as we have said before, a key moment.

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Market and on chains metrics:

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We are concerned about the significant inflow of bitcoins into the exchanges during this vigorous rally, as they could potentially exert selling pressure. As shown in the chart, large inflows preceded the crash due to the FTX bankruptcy.

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Analyzing the Spot-Derivatives trading volume ratio we observe a market dominated by derivatives, we strongly believe that organic growth has to be led by spot.

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Options open interest (OI) seem to be where the market is being the most influenced. As options OI is greater than the futures market for the first time, which is now at 1 year lows.

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Binance is the world's largest crypto exchange by a huge margin and is in the eye of the storm, the regulator has the spotlight on it in the light of recent events. It has achieved consistent growth since its founding in 2017, but its increasing dominance has been striking to watch since 2020, when it held around 25% of spot volume market share. Its market share approached 50% at the tail end of the 2021 bull market before retreating and again expanding to peak over 70% this year. Last week it was down to just 57%, much of which was due to changing fees and an outage.

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The first hit to Binance came in February when the New York Department of Financial Services (NYDFS) ordered Paxos to stop issuing BUSD while the Securities and Exchange Commission (SEC) sent a Wells notice to Paxos.

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The second and far more explosive hit came this week as the CFTC announced that it was charging Binance and its CEO/Founder Changpeng Zhao (“CZ”) with willful evasion of federal law and operating an illegal digital asset derivatives exchange.

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Binance is a relative newcomer to the derivatives space, listing its first instrument in mid-2019. Thus they were positioned perfectly when BitMEX, previously the largest crypto derivatives exchange, ran afoul of the CFTC in October 2020. Binance has been aggressive with perpetual futures listings, and since 2021 has only ever been surpassed by FTX, which had 182 instruments when it met its demise.

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Binance has dominated futures volumes for years and since the fall of FTX has consistently facilitated more than half of all BTC perpetuals volume.

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USDC is widely considered the highest quality stablecoin. It is a licensed US Money Transmitter; it holds its assets with large US financial institutions. While the initial flight from USDC to Tether during the USDC crisis is understandable, it is more interesting that these flows continued long after the uncertainty over USDC assets was resolved with no losses.

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Tether has a history of being drastically undercollateralized, has stubbornly rejected calls for transparency, is invested in opaque high-risk assets, and still can’t produce a high quality audit  and yet it is regaining its position as a safe haven, ironically spurred by the transparency of its competitor. Seems that Tether’s greatest weakness, uncertainty around its backing and business practices, is also a deliberate strength. During the month of March, Tether has printed an incredible 9 Billion.

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The concentration of activity around Binance and Tether is not good for the future of the ecosystem, let's hope that the adjustment of the market on all fronts is done quickly and in tune with the upcoming regulatory framework. 

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Classic markets

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The swift interventions by authorities worldwide to prevent systemic banking contagion have caused remarkable euphoria in the risk markets. The SP500 futures have risen almost vertically over the past week with no room for corrections. The market has managed to break the VWAP anchored at the previous highs but on really low volume, we expect a generalized pullback this week. We do not see a significant advance possible without a prior rest or digestion of the perceived gains.

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27/03/23 SP500 futures big picture

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03/04/23 SP500 futures big picture

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March had two OPEX (standard one and JPM collar roll) that influenced market behavior, now it remains to be seen which is the real direction the market wants to take. As we said last week, if macro and market events remained calm, all the massive bearish positioning generated by the fear around the banking crisis would be fuel for a short squeeze on all these puts.

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The gamma profile shows how the market moves from fear to greed at an unusual speed. We went from being in a maximum negative Gamma regime to a maximum positive Gamma regime in just over a week. A market with such a high positive GEX (gamma exposure) notional should severely slow down the buying momentum by having the market makers hedge against the market. 

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It certainly seems difficult for the market to surpass the 4100 - 4200 points gamma call wall during this Easter week.

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SPX Gamma profile 27/03/23

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SPX Gamma profile 03/04/23

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