Strong Dollar Pummels Risk Assets
Global markets opened risk-off at the open of Sunday night futures trading, and sold off further into the morning as volatility jumped, and the dollar approached multi-decade highs.
Risk Reverses as Dollar Strengthens
Today’s issue will cover legacy market dynamics and evaluate the current state of the “liquidity tide.” Readers are familiar with bitcoin and equity markets trading in tandem, we cover the relationship closely.
We also closely follow the volatility dynamics across asset classes, as the levels of historical and implied volatility in an asset class are very helpful for evaluating relative risk.
Before diving in, let’s revisit our current thesis on the state of global risk markets:
A large slowdown is amidst throughout the global economy, as short-sighted energy policy has worked to keep inflationary pressures elevated. Although equities and risk broadly have felt relief since the middle of June, we were and are of the belief that this is a bear market rally with further pain to be felt across risk.
Previous Issues:
July 20th - Caution: Bear Market Rallies
Aug 12th - Rising Speculation - Evaluating The Explosion In Derivatives Interest
Global markets opened risk-off at the open of Sunday night futures trading, and sold off further into the morning as volatility jumped, and the dollar (as seen by the DXY) approached multi-decade highs once again.
A trap was indeed set last week for global risk markets, as a divergence between declining implied risk (VIX), a strengthening dollar, and complacent equities was the perfect storm for an imminent reversal.
The VIX, which represents the market's expectation for front-month volatility for the S&P 500 index, is notably smaller than the implied volatility in bitcoin options markets, by an approximate factor of three.
Shown below is the 1-month forward implied volatility for bitcoin, which can be thought of as similar to the VIX. Whereas equities are currently trading with a 24% expected volatility for the next month (as expressed by VIX at 24), the options market for bitcoin implies 71% volatility for 1-month contracts.
Thus, bitcoin’s underperformance relative to equities throughout the bear market rally and subsequent draw down from its local high, is worrisome for bulls, and telling in general about demand for the asset at current market prices.
We are only being objective. Bitcoin has served as beta to equities to the upside and downside throughout 2022, but only barely rallied with the same fervor and upside volatility throughout this summer bounce as equities melted upward.
While global equities are dominantly driven by passive flows from pensions/investment funds, the bitcoin market is severely lacking major buyers at these levels. Many of the biggest players from 2020/2021 are all either fully deployed and strapped for cash, insolvent, or structurally sidelined (e.g., Grayscale Bitcoin Trust).
With that in mind, the interim result is telling of a lack of relative performance against global risk markets.
As rising yields and a strong dollar place increasing pressure on global equities, one should ask themselves what are the likely outcomes of further risk-off positioning in equities, and what is the likely response for the less liquid bitcoin market.
As equity markets begin to teeter over, and volatility in the legacy system increases through this deleveraging, we are increasingly confident in our belief that additional pain is the likely path before long in the bitcoin market, and opportunistic investors should in turn be ready with a cash allocation.
Bitcoin denominated in shares of the S&P 500 is approaching its 2022 lows:
Given the relative historical correlation between the two asset classes, the historical and implied volatility of the bitcoin market, and the likely path forward for the global economy, today’s price action reiterates our short/medium-term market outlook that the low for bitcoin is not yet in.
This is not as much of a bitcoin-specific tweet as it is a dollar-specific one.
Dollar strength in a monetary tightening cycle, with still rising yields, as implied risk across global markets remains relatively low (despite a large increase today).
Over the short/medium term, a cash position is likely the asymmetric bet (in bitcoin terms).
Over the long -term, bitcoin remains completely mispriced as a neutral hard monetary asset purpose-built for the digital age.
Thank you for reading Bitcoin Magazine Pro, we sincerely appreciate your support! If you found this article useful, please leave a like and let us know your thoughts in the comments section.
As always, honest and clear analysis. Really proud of you here, Dylan. You are standing up and walking tall, calling it like you see it.
Hi, are you guys not publishing DAILY anymore?