Executive Summary
We provide a brief update on our research views on select tokens in our coverage, taking into account developments specific to each project and changes in the macroeconomic and geopolitical environments that are impacting risk appetite. Our last general update was on February 1, 2022, shortly after the January rally.
Macro Conditions
The Goldilocks scenario of the US economy and inflation being not too hot, not too cold continues. In fact, the employment situation is turning out stronger than expected, with nonfarm payrolls and unemployment claims both indicating that lower end, service sector jobs continue to be in shortage.
However, the market narrative is starting to shift. What drove the January rally was a thinking that interest rate hikes will soon be over, with inflation well on its way down, but no visible damage to the US economy. This is shifting towards a recognition that inflation might be stickier than anticipated and interest rates will need to go higher, so there is still potential for damage to the economy. While this latter view is not fully priced in, we summarize the adjustments as:
Inflation. After coming in below expectations for October thru December 2022, upward revision to these headline but preliminary figures essentially doubled the annualized rate to over 3%. Then the January CPI figure disappointed to the upside. This is highlighting to the market that the decline in inflation rate (at least on a YoY basis) will unlikely be a straight line down to the Fed’s 2% target, and we risk experiencing a re-acceleration of price increases. The latest example is last Friday’s PCE data +0.6% MoM versus expectations of +0.4% MoM.
Employment. The low end jobs have remained tight and are seeing sticky wage increases. This is particularly the case in service industries where there are still shortage of labor. Historically, interest rate hikes by the Federal Reserve has less influence on service activities / prices than they do in the industrial / cyclical sectors—which suggests that core inflation may be stickier than previously thought.
Job loss. As the economy adjusts, so do corporates in previously outperforming sectors catering to “at home” consumption. We continue to track mass layoffs spreading beyond the technology sector into more traditional retail, media and consumer brands. These do seem to be higher salary positions, and implies a greater loss of consumption power.
Within the Fed’s mandate, #1 inflation and #2 employment are the most important—GDP growth and middle income jobs are not as high on their priority list. Therefore, the Fed can and will further squeeze the economy if inflation does not continue to decline.
The economy has been stronger than expected recently, and we think this has been the primary driver of the market rally YTD. As can be seen in the Chicago Fed’s NFCI breakdown (Exhibit B), looser financial conditions in recent months has been driven by higher risk appetite and cheaper credit spreads. Both of these factors are, in our opinion, reflections of the better than expected economy.
So the economy remains robust and can handle stronger medicine, the question is if stronger medicine is needed. Recently, 2 non-voting members of the Federal Reserve’s interest rate setting committee gave speeches suggesting support for 50bps rate hikes last month, raising the possibility for a bigger hike when the FOMC meets next on March 21st-22nd.
Cryptocurrencies Risk-Reward
The risk of more aggressive Fed response in late March has hurt risk assets this past week, along with stronger USD and higher bond yield. This reflects a shift in market narrative from “the economy is doing well” (and the resulting loosening of liquidity conditions) to “rates are going higher for longer”.
In this context of rising interest rates in the past 2 months, risk assets have done very well, particularly BTC +42% and ETH +37% since the end of December. We continue to favor BTC over ETH, and believe that ETH has more room to pull back towards the $1500 level on rising interest rate fear plus selling pressure from the upcoming staked ETH unlock (Shanghai upgrade targeting late March or early April). BTC, on the other hand, has seen strong support with sticky long-term holdings and less speculation (higher spot to futures volume at 53%, compared to ETH 16%).
We are maintaining our view that liquidity conditions continue to be a dominant driver of cryptocurrency performance for now, and since we do not believe that additional 1-2 rate hikes for 25-50bps incrementally in mid-2023 will drag down the U.S. economy in the next 2-3 months, we remain positive on the cryptocurrency market risk-reward in the near term. But as we have been anticipating for 2023, volatility will be a very prominent feature in the market.
GSG Coverage Update
The following is a summary of our current coverage and key changes to our ratings and price estimates.
To access the complete write-up of this research report by GSG, please click on "Update for Recent Market Developments".