When the Fed hiked rates swiftly and at an unprecedented pace through 2022, it was anticipated that the economy would buckle and we would enter a recession. However, nothing of the sort has happened and economic indicators are still fairly strong. So, why did the recession not occur, and are we out of the woods? How does this interplay with digital assets?
What is a recession? A technical recession is two consecutive quarters of negative GDP growth. In other words, the economy shrinks quarter over quarter for two consecutive quarters. However, a “recession” that spooks the market is a verdict given by the National Bureau of Economic Research (NBER) in the US. It is based on their internal methodology where they need to see a broad-based decline in various economic indicators to make their determination. These economic indicators include GDP, unemployment, real income, industrial production, etc. Any reference to recession hereafter refers to an NBER recession.
We have had 3 economic recessions in the 21st Century, as per the NBER methodology. One right after the dot com bubble burst in 2001, the second after the housing market bubble burst in late 2007, and a third and brief recession around Covid in early 2020.
Why was a recession expected now? The Fed started hiking rates at an unprecedented rate as a reaction to the high inflation, and historically, this has often resulted in a recession. This is quite understandable as, simplistically: tighter credit leads to less disposable income/less free cash flow resulting in lower spending/lower industrial productivity further leading to lower corporate earnings resulting in layoffs and a higher unemployment rate, culminating in a recession.
However, we have not moved from a ‘tighter credit’ environment into a ‘less disposable income/less free cash flow’ phase just yet. This is most likely due to the significant amount of stimulus given directly to families and businesses during COVID-19, and the long duration of zero interest rates we have had that allowed corporates to raise long-term debt at extremely low rates. This has allowed retail users to continue spending on non-essentials, and for businesses to report strong earnings. In fact, some of the COVID-19 stimuli are still available to the economy.
The stimuli will ultimately end and corporates will have to raise debt again with almost $1tn of debt up for refinancing in 2024 and 2025, probably at much higher rates than what they have been used to. Ultimately, the chronology of events leads to the most obvious of indicators: Unemployment. Historically, every recession has coincided with spikes in the unemployment rate, as seen in the chart below.
However, as you can also see from the chart, the current unemployment rate is almost at an all-time low. While there have been murmurs of stress in certain sectors such as technology it has not yet resulted in an economy-wide stress on employment levels.
What next on the macro front? The markets were expecting the Fed to cut rates at least once this year and multiple times the next year, which was partly responsible for the rally earlier this year. This was because they were expecting a recession and for the Fed to react to it by cutting rates, as they have done historically. However, the indicators stayed strong, there was no recession, and the Fed continued signaling that we are probably in a ‘higher for longer’ rate environment. This resulted in a steeping of the yield curve which decimated the bond market (especially longer-dated). As you can see from the yield curve graphs below from April 2023 and October 2023, there has been a significant steepening at the longer ends of the curve, and the market has recalibrated to a ‘higher for longer’ environment.
While this would have typically been calamitous for equities as well, especially for tech and growth stocks, these assets have not felt the pain as much as the bond markets. This is due to strong earnings and positive analyst reports. However, as rates remain higher for longer and the retail and corporates start feeling the pinch, it waits to be seen how well the earnings cope. It is worth noting here that S&P 500’s move this year has mostly come from the Top 7 stocks as the rest of the basket is relatively flat. The Russell 2000 index (an index of small cap stocks in the US) has however broken down to its new lows in the last 2 years. It therefore appears that there is a flight of capital from small caps to selective large cap assets, whose weightage in the leading indices is perhaps painting a rosier picture of the economy.
Will we see a recession? The markets and “experts” are torn on this. We can see opinions ranging from the possibility of a depression to the possibility of an AI-driven productivity boom that kickstarts a massive bull run. We believe that the Fed will maintain rates higher until something breaks in the system that makes unemployment go higher and spending lower – and there are second and third-order indications of this scenario. Whether this results in a recession is not clear but it is very clear that the era of cheap money is over (at least for now). How the Fed reacts to something breaking in the system will determine the steepness and velocity of the next bull run.
How does this play into digital assets? Digital assets had only seen a zero-rate environment prior to 2022. In that climate, there was excessive cheap capital and we were in an ‘up only’ environment. The best case scenario for digital assets would be for something to break in the system that propels the Fed to cut rates and move back into a zero-rate environment, which may not happen any time soon.
The asset class is sufficiently large now and has sufficient mindshare from retail and institutions to ensure that it will continue to flourish in the long term. Even in a higher rate environment, there could be interesting tailwinds such as Bitcoin ETF, Bitcoin halving, favourable regulations, etc. that can bring fresh capital into the ecosystem. There is still a lot of growth here and a lot of alpha to be generated in both the private and public markets. However, it is necessary for capital deployers to be highly selective in their investments and be research and thesis-driven.
PROJECT SPOTLIGHT
Arcana
Arcana has built a suite of products where developers don’t need to think about wallets, keys, blockchains, authentication, and gas fees, and instead just focus building the product for users. The team recently launched SendIt, a product which links a wallet to your email address/social account, to make it easier to send funds to non-native web3 users. Over 100k early users joined the waitlist and the product was launched in August. By late September, it had facilitated 1.5M+ transactions with 400k+ users across 172 countries. Based on user feedback, the Arcana team introduced the ‘request’ feature, through which users were able to request money from other users. To encourage adoption, the team also started a SendIT Community Ambassador Program on Zealy.
Moreover, the Arcana token launch is around the corner. The team is preparing for the airdrop to the community at the moment. The public sale of the $XAR token is scheduled to go live on Republic in the first half of November, with the token publicly launching within this quarter as conversations with exchanges continue. We are excited about the next phase of Arcana’s growth!
MARKET NEWS
- The trial of Sam Bankman-Fried has been underway this month. Bankman-Fried took the witness stand hours after the prosecution rested its case, presented over 12 trial days, and gave a testimony that fit with the defense’s argument that he acted in good faith while running FTX. He began testifying on the 26th without jurors present, an unusual move by the judge who wanted to review the comments first to see if they were admissible. SBF faces seven criminal counts, including wire fraud, securities fraud and money laundering, that could land him in prison for more than 100 years if he is convicted.
- While there has been no outcome to the multiple Bitcoin spot Exchange Traded Fund (ETF) applications, news of possible approvals has led to volatile moves in BTC prices.
- A tweet by the cryptocurrency news site Cointelegraph falsely claimed that BlackRock’s iShares division had secured the SEC’s approval for a Bitcoin spot ETF. This claim spread rapidly, leading to Bitcoin’s price surging from $27,900 to $30,000. As the erroneous news was debunked, Bitcoin’s price dropped to around $28,000, showcasing the market’s sensitivity to such news.
- Later in the month, BlackRock’s proposed Bitcoin ETF was added to a clearinghouse eligibility file by the Depository Trust and Clearing Corporation (DTCC). The move was not indicative of any regulatory approval, but speculation surrounding it contributed to Bitcoin’s biggest two-day rally in seven months. The ticker for BlackRock’s ETF was later removed from DTCC’s list, causing a quick price drop of more than 3% within 30 minutes. And just few hours thereafter, it was discovered that the ticker had been there all this time since August!
- The SEC dropped charges against Ripple executives, bringing an unexpected end to the anticipated trial scheduled for the next year, although other allegations regarding XRP’s supply and sale remained.
- Tether CEO revealed plans for real-time reporting of USDT reserves by 2024, along with a focus on greater transparency, advanced technology investments, regulatory negotiations, and renewable energy initiatives.
- Binance’s US affiliate halted direct dollar withdrawals on October 17, marking a notable development in crypto regulatory and operational landscapes. The platform updated its policy, ceasing all direct US dollar withdrawals from that date. Binance US has provided an alternative for users to withdraw U.S. dollar funds from their accounts via the Silvergate Exchange Network (SEN).
- The Wall Street Journal cited Elliptic as a source for their story claiming Hamas had raised over $100 million in crypto, but Elliptic itself looked at the same data and reached the exact opposite conclusion.
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Warm Regards,
Woodstock Team
