- Frightful Fours
In Eastern numerology, number 4s are considered to be the unluckiest of numbers.
Similarly in markets, Wave 4s are notorious for being unpredictable, and designed to inflict maximum pain on a maximum number of participants.
Make no mistake, what we are seeing now in risk markets are characteristic of Wave 4s.
We are sticking with our view that this bounce since November 2022 lows, is just a Wave 4 correction and we have a final Wave 5 selloff to go.
The extension we are currently seeing so far in 2023 falls within the parameters of the Wave 4, even if it has broken some near-term technical levels to the topside, thereby increasing bullish momentum.
1.1 Wave 4
Elliott Wave guidelines for Wave 4 are the following:
- Wave 4 will most often retrace more than 20% of Wave 3
- Wave 4 will very often retrace about 38.2% of Wave 3.
- Wave 4 does not often retrace Wave 3 by more than 50%.
Hence we have a zone of minimum 20% of Wave 3, and between the 38.2% to 50% Fibonacci retracement as the Wave 4 target, with >50% the invalidation level for our base case.
At this point, we have now surpassed the 20% retracement of Wave 3 for all markets, but only the USD has reached its Wave 4 target of 50% retracement of Wave 3.
The 20% retracement levels are:
The 38.2% to 50% retracement levels are:
BTC: 27,100 – 31,850
ETH: 1911 – 2280
NASDAQ: 12,312 – 12,880
10-year: 3.2% – 2.85%
DXY: 105 – 102
Technically until these levels are broken, Wave 4 is still in play and a final Wave 5 for these markets that break the lows should not be ruled out. Without a doubt, the pain trade is lower right now.
1.2 Pivot Hopes
What has provided the bullish fuel in terms of reflexive sentiment to drive this rally?
Since the October 2022 low, the Fed has been getting incrementally more hawkish – with their December FOMC the most hawkish of all in terms of rate forecasts.
However, the market has started “fighting the Fed” again, similar to Q1 last year, believing the Fed will not be able to carry out their 2023 forecasts.
The market is getting its confidence from a rapid softening of actual CPI, and more importantly, recessionary December 2022 economic data that implies the CPI track will fall to 2% by year-end.
However, we have yet to see other hard data indicators turn – such as employment or GDP, but those are treated as lagging indicators by the market.
Nonetheless, we believe the Fed will want to see hard evidence first before having the confidence to pause or even lower interest rates. They would be wary of a 1970s-esque double-dip inflation happening again.
Furthermore, the FOMC is certainly going to want to see inflation data for January and February (released the month after) to have confidence in the slowdown.
In terms of what the market is pricing for Fed hikes, we are now down to just 2 more 25bp hikes, one in February 2023 and one in March 2023 before cuts come as early as H2 2023.
This means the market expects that by January 2024, rates will be lower than they are in January 2023. In stark contrast, the Fed expects rates to be at least 1% higher than they are now!
1.3 FOMC’s Ire
While we expect the 1 February FOMC to push back strongly against this pricing, we believe the 22 March FOMC will be the moment of truth, when updated rate forecasts will be released.
Should there be no adjustment to the median 2023 dot, then we expect markets will be in for a rude shock.
What will raise the FOMC’s ire is how quickly financial conditions have loosened in this period which, together with the rally of meme stocks and crypto, risks severely derailing their fight against inflation.
They shared in the December 2022 FOMC minutes, that “an unwarranted easing in financial conditions, especially if driven by a misperception by the public of the committee’s reaction function, would complicate the committee’s effort to restore price stability”.
Also, financial conditions are now back to levels at the June 2022 meeting – when the Fed rate was only 75bp and inflation was at its peak of 9.1%!
Furthermore, the excesses of the prior inflationary regime are starting to reemerge.
The meme stock basket is now up 25%, while Alt-coins like Solana have doubled in value in less than a month!
Finally, total NFT market cap has quietly crept up close to last year’s high levels of ~9-9.5m ETH, worth $13.3bn at today’s prices.
While we wrote in our first market update of the year that NFT prices were a harbinger for a broader rally to come, we do not expect this to be sustained while the Fed is still on a warpath against inflation, and all the assets that feed it.
1.4 Liquidity Rules
While the green shoots of a bottom in crypto have emerged, it is hard to be certain that a new bull market is on the cards.
It seems like the temporary pause of bad news after a year of constant shocks has allowed global liquidity to take over and sweep crypto up in this risk rally.
Some hallmarks of strong bull markets are:
- GBTC moving into premium: Currently at -40% discount although off the lows of -48%.
2. BTC and ETH contango term structure, where a steep contango is indicative of strong demand: Currently there is a very slight contango of just 1-2%.
We believe that many crypto institutions who need to liquidate assets have chosen to buy time by preserving cash and cutting expenses instead. This has allowed crypto to once again have a high beta to the upside in this global risk rally.
However, we expect that many of these names would be highly reactive to signs of another dip. This means that selling pressure can quickly escalate if price begins breaking lower.
Hence, our view is that crypto is ultimately still beholden to the global liquidity cycle which, up till now, has been favorable so far this year. This has allowed prices to keep going higher.
The Fed’s QT is at full throttle now ($95bn/month), effectively shrinking the Fed’s balance sheet and reducing liquidity in the market. However, since the turn of the year, this tightening has been negated by the US Treasury releasing liquidity by running down its cash balance with the Fed (Treasury General Account), as a result of the debt ceiling being breached.
In a re-run of 2019, the Treasury has been forced to enact extraordinary measures that would release roughly $400bn into the banking system from now till August, thereby dampening the effects of QT for risk assets including crypto.
However, we expect that once the liquidity cycle turns negative again, we will see the start of Wave 5 for macro markets in this order:
- US Equities
- Global bond yields
2. Upcoming Risk Events (2023)
*Due to the change to quarterly physical settlements for our model portfolio, as outlined in our end-2022 Just Crypto, we will be updating these trades on a quarterly basis in our quarterly Just Crypto publication.
Weekly trade recommendations will now be more short-term in nature, and announced in the weekly broadcast, if any that week.
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