Blofin: December may be a turning point for the crypto market after the Fed's sharp rate hike

Considering the worsening inflation situation, the Fed seems to have no choice but to further increase the rate hike and push up the risk-free interest rate through continuous rate hikes. In the Fed's June meeting resolution, the Fed has decided to raise interest rates by 75 basis points, and the possibility of a 75 basis point rate hike in July has risen to more than 60%; in September and November, interest rates may be raised by 50 basis points respectively. Judging from Powell's attitude, the Fed seems to have decided to sacrifice some economic growth and employment in exchange for a certain degree of inflation reduction. There is no doubt that this will worsen the already stretched liquidity in the crypto market.

For the crypto market, the continued downturn in forward expectations is even more fatal. Affected by the sell-off, the current forward futures premium rate of mainstream crypto assets is significantly lower than the risk-free rate in the traditional market, which has led to the accelerated withdrawal of liquidity; there is no better way at present.

It seems that liquidity will not return in the short term. However, from a macro perspective, changes in U.S. Treasury yields and the U.S. mid-term elections may lead to a turnaround in the performance of the crypto asset market.

The performance of US Treasury yields is one of the signals of a turnaround in the performance of crypto assets. Due to the Fed's tough stance this year, the 2-year US Treasury yield has remained high, and the decision of the FOMC meeting on Thursday is an important factor in the future performance of the 2-year US Treasury yield. Once the 2-year-10-year US Treasury yield is inverted steadily, a recession will occur and continue. In the case that raising interest rates has proven difficult to control inflation, the Fed may adjust the plan and solve the inflation problem from other angles such as the supply chain.

In fact, some relevant signals have been revealed in the content of the Fed's June FOMC meeting. On the one hand, the Fed has once again raised its inflation and unemployment expectations for this year to 5.2%, while lowering its economic growth expectations for this year. On the other hand, the Fed's latest dot plot shows that interest rates will remain high in 2023 and gradually decline from 2024. However, since the current economic situation is not strong enough to withstand such a long recession, the time to start lowering interest rates may be earlier than the expectations of the dot plot.

So, when will this happen? The US midterm elections in November 2022 may be a key node. If inflation is still not under control at this time, voters may question the Biden administration's economic performance, which is undoubtedly what they do not want to see. At this time, the recession caused by the interest rate hike may be close to the limit that people can bear. The consumer confidence index was already lower than the level before and after the 2008 economic crisis in May, and further interest rate hikes may only cause more negative effects.

In addition, the Fed has also partially achieved its goal: the ACWI index, which reflects the liquidity level of the global capital market, shows that as of mid-June, liquidity has shrunk to the level at the end of 2020, and the over-issued currency and overflowing liquidity during the epidemic have basically been recovered. The Fed only needs to wait for the supply chain to recover and inflation to fall naturally before announcing that inflation "has returned to normal levels under policy regulation."

Therefore, the Fed meeting in December will be an important node for whether liquidity will return or not. It is worth noting that in the crypto market, the implied volatility of BTC forward call options significantly exceeds that of put options, and the volatility surface begins to tilt towards higher prices; this phenomenon did not occur in May. The changes in the volatility surface of forward BTC options suggest that some investors expect the Fed to relax monetary policy from December, and the crypto market may see the return of liquidity from the end of the year.

The rate hike at the June FOMC meeting on Thursday may exceed expectations, and the market is competing to digest the Fed's more aggressive tightening policy. Considering the risk exposure brought about by the rate hike and the upcoming semi-annual delivery of derivatives, the crypto market will still face significant selling pressure. In the short term, risk-averse strategies (such as risk reversal combinations) will still be the best choice for investors.