Markets Torn On Fed Rate Cut, Bitcoin Catch-Up Trade, Miner Relief

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Cliff-Notes:

• The market is largely uncertain if the Fed will go for a 50 or 25-bps cut next Wednesday.
• Bitcoin's market structure is very similar to its setup in mid-2019, when the Fed was starting maintenance cuts just prior to its last bull run.
• Whether the Fed has to pivot to more aggressive cuts or not, bitcoin's ascent is a certainty.

Stocks are nearing all-time highs and the first of several rate cuts are on the way from the Fed starting next week.

Markets are uncertain as to whether the Fed will start with a 25 or 50 basis-point cut. Starting small will signal that the Fed is confident that the economy is fine and its pace of slowdown is controlled, while starting with a 50-bps cut could signal that the Fed is nervous that the jobs market is deteriorating faster than anticipated, eliciting a more negative reaction in asset prices.

Nick Timiraos, the Chief Economics Correspondent for the Wall Street Journal, has served as a de facto monetary policy tool for the Fed throughout this cycle. Prior to FOMC meetings, he strongly hints at the Fed's decision to give markets a clear sense of what it will do well in advance—a tool that helped the Fed deliver its hikes this cycle while dampening market volatility. However, the article he released today only made markets more confused, and raised the odds that the Fed would deliver a more aggressive rate cut of 50 bps.

Here is the market's pricing for Wednesday's FOMC meeting, before and after Nick's WSJ article came out. The odds of a 25-bps cut dropped from 72% to 57%, while the odds of a 50-bps cut rose from 28% to 43%:

Chances are, this is what will happen based on prior Fed meetings:

• The FOMC will deliver a 25-bps rate cut
• The Fed's written statement will include language that the Fed will remain data-dependent, and larger incremental cuts are on the table as we move forward
  • Note: the Fed increased the pace of its rate hikes in 2022 when CPI proved to be unresponsive to the small 25-bps hikes that the Fed started out with. A shift higher to 50-bps cuts after starting at 25 would likely stir markets, but it isn't out of character for the Fed to change the pace of its policy rate moves based on incoming data.

This move would likely quell fear, keep credit spreads narrow, and push risk assets higher. A regime of lower rates means investors gradually move out on the risk curve—out of the $6.3 trillion locked up in money market funds due to less attractive T-bill yields and into longer duration assets like corporate bonds, small caps, and bitcoin. As the Fed delivers 250-300 bps worth of aggregate rate cuts, priced in over the next 12 months, this rotation into risk will take place.

What the Fed is getting ready to deliver next Wednesday is a maintenance rate cut. As CPI inflation has fallen from 9.1% to 2.5% while the Fed Funds rate has remained at 5.5% on the upper bound, real rates (rates adjusted for inflation) have grown substantially more restrictive; the 2-year real US Treasury yield has risen from -3% in early 2022 to 2.06% at the time of writing. Maintenance cuts mean lowering the policy rate to what's called the neutral rate, maintaining or lowering the current level of restrictiveness to where the Fed can hold for a multi-year period without fear of financial conditions getting too restrictive.

The Fed's current long-term neutral rate is projected at 2.5%, which is 300 bps lower than the upper end of Fed Funds at 5.5%. As the Fed cuts to neutral without a surge in layoffs and a spike in the unemployment rate, risk assets love it. Financial conditions (which are already loose) get even looser, businesses get even more breathing room to roll their debt, and investors who are newly imbued with a confident economic outlook move out on the risk curve. Stocks love maintenance cuts, so BTC which is traded as a long-duration risk asset, will love them too. The last time the Fed performed maintenance cuts 5 years ago, the S&P 500 soared 12.4% (pre-COVID), in contrast to the prior cutting cycle where the Fed was cutting in response to a recession that had already taken hold, and the S&P 500 plunged 54.5%:

The size of the Fed's rate cut next week is far less important than the ~250 bps of cuts that are priced in over the next 12 months.

The further easing of already loose financial conditions will be a boon for risk assets, and since Bitcoin is an extremely rate-sensitive asset, it stands to appreciate in an outsized manner relative to the rest of the market.

If cooling in the labor market remains contained and the Fed isn't forced to cut more aggressively, the path of least resistance for Bitcoin as the Fed delivers its rate cuts is higher.

If cooling in the labor market accelerates, driving the Fed to cut more aggressively and potentially deliver an emergency liquidity measure, Bitcoin will stumble in the near term but push higher in the long term.

The path for bitcoin is a certainty because the resolution of each credit cycle is a certainty. The severity of the downturn and the degree of subsequent financial easing are what determine the speed of bitcoin's ascent.

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Bitcoin has a lot of catching up to do relative to the rest of the risk bucket.

Global liquidity is inflecting higher, with gold sniffing it out and breaking past new all-time highs, and the S&P 500 hovering around all-time high levels as well. Rate cuts next week, further easing of financial conditions, and Q4 seasonality for risk markets are the probable catalysts that BTC needs to break this consolidation with real momentum and drive to and through new all-time highs.

We're truly just a stone's throw away from the $80,000 mark once this protracted and healthy period of consolidation comes to an end:

Miners have been on the verge of a capitulation event for many weeks. This summer has not been kind to them, as bitcoin's 6-month downward drift has held marginal revenue for miners at all-time lows. The catalyst of rate cuts beginning next week and bitcoin ideally gathering the momentum to break its choppy downward price action will provide much-needed relief for miners who've been struggling with profitability.

The closest analog to today's environment for BTC is 2019-early 2020. Price has been chopping around between $55,000 and $75,000. Coins have been moving from weaker, more speculative hands that drove the price to these heights to convicted, long-term holders who are unphased by Bitcoin's volatility, plan to endure, and hold it for years and decades at a time.

Bitcoin has been steadily drifting lower for 6 months while the network's average purchase price has been rising. The proverbial floor for bitcoin's price, the level that long-term holders back up the truck and buy more, is rising. With less unrealized profit in the market, and ever-higher levels being treated as a floor, bitcoin has more upside for the eventual resumption of its bull market.

Bitcoin did a 6x from its consolidation range at ~$10,000 throughout 2019 to its initial cycle peak of $64,000 in early 2021. If bitcoin does even half of that this time around, it would mean that $100,000 per coin is reached before BTC tops out for the cycle. The gradual decline in MVRV, caused by bitcoin's price drifting lower as the network's average purchase price rises, is the same structure we observed last time the Fed moved from pausing to maintenance cuts back in 2019:

The Fed's rate cuts beginning next week will cause interest rate differentials between USD and other global central banks to narrow, making borrowing in cheaper currencies to invest in US capital markets less attractive. We saw how markets sold off in August when the yen carry trade started to become less viable. The impact of further easing in US financial markets over the next several months will be plenty to offset any sell-off related to the unwind of carry trades.

Final thought: the second half of September is historically the worst calendar period of the year for risk, so be ready for some potential near-term pain.

Take it easy,

Joe Consorti

Theya is the world's simplest Bitcoin self-custody solution. With our modular multi-sig vaults, you decide how to hold your keys.

Whether you want all your keys offline, shared custody with trusted contacts, or robust mobile vaults across multiple iPhones, it's Your Keys, Your Bitcoin.

Download Theya on the App Store.