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1/469 The has been a very fundamental shift at the Federal Reserve.

The Fed has flipped decidedly hawkish. Their main worry is not employment, it is inflation. And to fight inflation the Fed has to increase interest rates.

Here's a thread about the Fed and crashing markets.
Fret not, thread wont' be that long!
2/ It all started with Powell's "inflation no longer transitory" comment of November 30

and culminated with the FOMC minutes released on Wednesday, where Fed officials discussed faster balance sheet normalization.

The latter is worrysome enough to trigger a bear market.
3/ This has been extraordinarily bearish due to the speed of the Fed's turnaround.

Raising rates or tapering quantitative easing (QE) should not be bearish enough to change the upwards trend across assets.

But this goes beyond that.
4/ This is a matter of how fast the Fed flipped hawkish

and a matter of potential accelerated balance sheet normalization.
5/ Here's the Fed's chronology

- Expecting no rate hikes for 2022 (June FOMC)

- expecting half a hike (median estimate) for 2022 and announcing QE tapering would start soon (September FOMC)

- announcing slow QE tapering (November FOMC)
6/

- expecting three hikes plus accelerated QE tapering (December FOMC)

- discussing accelerated balance sheet normalization for 2022 (December FOMC, became known in the minutes released this week).
7/ So in less than six months, the Fed went from expecting no rate hikes for 2022 (party goes on)

to expecting three rate hikes, accelerated taper, and discussing accelerated balance sheet normalization.
8/ Balance sheet normalization was not in anybody's radar for a long time.

Not only is this now a possibility in the near term, but also the Fed is talking about doing so faster than in 2018.

That's why crypto assets dropped 15%-30% in two days last week.
9/ Accelearted normalization would be dreadfully bearish.

What does balance sheet normalization mean?

It means reversing the asset purchases conducted under QE. This is also known as quantitative tightening (QT).
10/ The Fed had been adding $120 billion a month via QE since the coronacrash.

Accelerated QT would mean doing the opposite at more than $50 billion a month ($50 was the size of QT in 2018).

Say - $80 billion.
11/ Under that scenario, the Fed goes from pumping an additional $120 billion into the economy, to susbtracting $80 billion from the economy.

A $200 billion per month difference.
12/ How does that matter for crypto?

Simple. Crypto assets are at the furthest end of the risk curve.

Just as they benefited from extraoridnarily lax monetary policy, they suffer from unexpectedly tight monetary policy,

as money shifts away into safer asset classes.
13/ Furthermore, bitcoin is now a macro asset that trades as a proxy for liquidity conditions.

As liquidity diminishes, macro players now in the fray sell bitcoin, an all of crypto follows

(crypto correlations with bitcoin dropping anytime soon are a pipedream)
14/ Let's put this in shitcoin terms.

What happens when defi projects increase yields via increased supply?

Prices go down.

And what happens when projects burn supply?

Prices go up.
15/ The Fed is here your shitcoin master in chief.

And the US dollar is the king shitcoin.

As the Fed goes from increasing supply (the size of its balance sheet) to burning supply, the US dollar starts going up.

And everything else goes down vis-a-vis the dollar.
16/ So what now?

Crypto assets have already dropped dramatically.

$BTC is already down 40% from all time highs, $ETH is down 30%.

Prices are oversold and holding at major support.

Yet finding has not turned extremely negative.
17/ I'm thinking as follows

#1 bounce next couple of days
#2 Up or down depending on Wednesday's inflation data
#3 Stay defensive into end of Q1
#4 Buy in May and go away? Impossible to anticipate when the time to turn full bull will be. Have to be patient.
18/ Wednesday will have the US inflation data.

Think prices should chop around 41k and 44k until then, with an upwards skew given how strong the rejection of the lows has been.
19/ If CPI surprises on the downside, expect prices to pop and trend for a while.

If CPI surprises on the upside, "lights out", $BTC is going into the 30s, tradfi will make sure of it.
20/ If the number comes in line with the forecasts, at 7.1%, hard to tell, would make sense for bears to attempt to break the lows, fake breakout, and a rabid rally to ensue given the chart.

That said, crypto will follow bitcoin, and bitcoin will follow stocks.
21/ TL;DR so far

The Fed is saying it is willing to prick the bubble.

The bear case is they do.

The bull case is inflation starts to consistently surprise on the low side, and they don't need to.

Inflation is everything.
22/ Inflation will eventually start heading lower.

For three reasons:

- tighter monitary policy
- diminishing supply side bottlenecks
- dominant long-term deflationary forces.
23/ The market expects inflation to be much lower by year end.

Question is, will inflation drop fast enough, or will the Fed cuck us all?
24/ And the final question is, can crypto ignore the Fed if it decides to go all out wielding a deflationary machete?

I doubt it

"Don't fight the Fed" applies both ways, up and down.

If the Fed is *too hawkish* then Houston, we have a problem.

/END
Yes, inflation data is the key.

The Fed flips dove again once inflation starts coming in low OR credit markets collapse (triggered by the Fed itself).


As I said on the replies I purposefully oversimplified the dollar analogy.

The Fed going hawkish via QT makes rates go up and the treasuries curve to steepen (aka bear steepener).

That tightens monetary conditions and is negative for assets far out the risk curve and tech.

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Great thread. I talk about this same issue with @stephanlivera. One factor that's important is that fiscal constraints may prevent the Fed tightening much (the debt position is far greater today than in e.g. 1980). They may also need to quickly reverse.

Interesting thread. If this holds true, then the long party we have had in pvt / venture markets is now beginning to come to an end. The Fed's choking off easy money as inflation fears rise; that is the equivalent of the last call from the bar.