What should markets expect as we head into year end?
December 18, 2023
Global Macro Highlights
📉 Inflation slowed to a 3.1% annual rate in November
⏸️ Fed holds rates steady, indicates three cuts coming in 2024
❌ Fed's Williams douses Wall Street's rate-cut speculation
This week was an event heavy one for macro, starting with the US November CPI print. For once, there was little in the way of fireworks - the MoM number was a little higher than expected, but YoY figures were all in line across headline and core metrics. With little to trade over, markets looked to the last FOMC meeting for the year.
As an event, it did not disappoint. The Fed held rates as widely expected, but the dot plot showed an expectation for 3 rate cuts from here by end 2024. In his press conference, Chair Powell embraced the dovishness that markets had priced into the curve, instead of pushing back like most would have expected. This stance caught market players off guard, and proceeded to light a second fire under the Santa rally that had been ongoing for the last 6 weeks.
The S&P 500 notched a 1.37% gain on Thursday and closed the week up 2.49%, while 10Y treasury yields are down 31 bps over the week. The market proceeded to price in further cuts into the Fed Funds curve, with an expectation for 6 cuts to take place by next December, and the first cut to come in March.
Perhaps worried that the message was being pushed out too far, Fed Governor Williams spoke out Friday that the Fed wasn’t talking about rate cuts right now, and that it was ‘premature to be even thinking about that’. This did stage a minor rebound in the weak Dollar, but didn’t seem to do much to quell the euphoria in markets. The 10Y yield closed pretty near the week’s lows.
Malaysian Market Highlights
🔀 Cabinet reshuffle: Clear signal of Unity Govt moving forward
🇲🇾 Ringgit opens higher against US dollar after Fed signalled rate cuts next year
Despite the changes in the upper echelons of government, there was little on the local scene that impacted markets here. Things were sleepy while waiting for the Fed, but did get moving soon after. At Thursday’s open, USD/MYR had an opening gap lower, trading as low as RM 4.6550 on the interbank market, but closed higher at RM 4.6690. Thursday’s 10Y MGS auction garnered some interest locally, with a bid-to-cover ratio near 2.73 times.
The government bond yield curve ended the week largely unchanged:
In this environment of stable benchmark yields and a supportive external narrative, corporate bonds rallied.
The Halogen Shariah Ringgit Income Fund continued to notch another week of steady returns, further underlining its low volatility credentials.
Crypto Market Highlights
🤝 BlackRock's Bitcoin ETF Now Invites Participation From Wall Street Banks
📱 Sales of Solana Phone Surge as Traders Chase BONK Arbitrage
After successive weeks of gains, Bitcoin has taken some time to consolidate, with choppy price action being led by speculative position liquidation. We had multiple flash crashes over the week in crypto, starting Monday morning where over $300 million of long liquidations took place in BTC derivatives, as price fell from $43,800 to $40,400.
Naturally, that level seemed to attract buyers, but Bitcoin has since been trading in a consolidative manner. Crypto was also subjected to another mini flash crash on Wednesday night after Coindesk quoted a JPMorgan report claiming it was cautious on crypto’s 2024 outlook.
Not everything has been doom and gloom though, with the street getting word of further developments in the ETF space. Several more managers have been amending their applications with the SEC to include cash creation as a mechanic for ETF unit creation, though still leaving the door open to allow for the in-kind method as well. This also opens the door for major US banks to act as participants and provide liquidity, though from an infrastructure perspective no one save perhaps JPMorgan is likely ready to support that yet.
Despite woes in the major crypto pairs, it is clearly still ‘alt season’, with altcoins still printing strong gains. The Solana ecosystem went bonkers over the BONK memecoin, driving it briefly above the $2 billion market cap mark. The developers of the Saga phone, heralded to be a web3 native phone, were advertising an airdrop of the BONK token for every phone purchase. At the price of BONK then, one could buy the phone and sell the BONK perpetual swap derivative, netting them a free phone and some leftover change.
What are we monitoring for the week ahead
What does all of this mean? Our thoughts
The Fed pushback most had expected during the FOMC meeting might have started instead via Federal Reserve speeches. Perhaps thinking that the market was taking things too far (6 cuts by Dec 24 2023 does seem excessive when inflation isn’t quite dead yet), Fed Governor Williams might have felt the need to undo some of the damage that Chair Powell did. We will need to see if other officials start to echo this sentiment too, but so far the Federal Reserve speaker schedule looks clear till year end.
Whether intentional or not, the market clearly took Powell’s words to heart. The S&P 500 is now a mere 2.5% away from its all time high. Though the Magnificent 7 had carried the index for much of the year, the recent rally in the index over the last few weeks has been more broad based. Over 60% of its constituent stocks are now trading above their 200 day moving averages. By all accounts, it’s been an excellent year for US equities despite the challenges and volatility over 2023. And sentiment does seem to remain bullish - market commentary keeps alluding to terms like ‘soft landing’ and ‘immaculate disinflation’.
What should markets expect as we head into year end? It’s rather likely that liquidity will start to dry up going into the middle of next week, and after the last Bank of Japan meeting for the year. From there, there are two schools of thought on year end seasonality, as far as institutions go. The first would be that, after a good run, it would be time to lighten the books and lock in the performance for the year. Trading desks at banks would be less likely to warehouse risks.
From there, we can extrapolate that risky assets are more likely to either consolidate or even pare back recent gains. For US assets, this could very likely be the case - especially given the recent quadruple option expiry roll last Friday. As markets roll their covered call and tail risk hedge positions for next year, we can expect option market makers to need to sell spot delta to hedge some of that risk.
The other school of thought, and more pertinent to markets or assets which didn’t have such impressive years, is to load up the books for what is typically a buoyant seasonal trade in January. We saw some of this behaviour in the recent 10Y MGS auction. Malaysian fixed income traders haven’t had a good year at all, and their books were likely underweight going into the FOMC event. Ex post, it’s reasonable to expect interest to reload those positions. This also has the convenient effect of locking in gains/losses and other trading costs in 2023, which don’t get carried over into next year.
We saw a good cleansing of speculative long positions in Bitcoin over the week. According to Coinglass, there was a $1 billion reduction in OI over Monday’s crash alone, and a further $700 million reduction since then. There were also reports of spot inflows into Bitcoin exchanges, indicating that spot buyers were also looking to sell some of their positions.
Given that price has remained supported at key levels, we think it’s more likely that Bitcoin and other crypto majors consolidate in their recent ranges. The wipeout in OI reduces the likelihood of another liquidation cascade, but this could change the longer we consolidate here.
One piece of good news that we’ve been seeing is the amendment by various asset managers this week on their ETF applications, where adjustments were made to cater for cash creation instead. Though in-kind creation is less operationally intensive, one can also take this as a sign that the Fed is implicitly telling applicants that the only way forward is via cash creation. Indirectly, this further improves the approval odds for those who are making these amendments.
Despite how crypto majors have retreated from their recent highs, broad sentiment in the crypto market still remains buoyant. Perhaps a bit too buoyant, as recent gains in some projects can only be described as overly speculative. The BONK meme token hype culminated with a listing on Binance and the Saga phone being sold out, after which the token fell some 30% from its recent high - within 24 hours. The INJ token (for the Injective protocol) has seen a weekly gain of over 50% and a MTD gain of almost 100%, as speculation for token airdrops from projects developing on INJ started to come alive.
Given the less institutional nature of crypto, and what looks like clear bullish sentiment in that space, it’s a bit harder to look at this market through the lens of seasonality. There is some anecdotal evidence that Bitcoin tends to trade weaker going into the last week of December, as that is when major option positions expire and positions need to be rolled.
With the hype of the ETF approval slated for January, we expect that this might have a bit of weight to it. We still maintain expectations for a buy rumour, sell fact outcome on the ETF approval. As we expect price to remain consolidative for now, a portfolio hedge via Bitcoin puts could likely get cheaper as we head into Christmas.
On another note, as the holiday season approaches, we're taking a brief pause from our weekly newsletter to enjoy the Christmas break.
Wishing you all a joyous holiday season, and we look forward to reconnecting with you in our next edition in January 2024!
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