Crypto In the Hawk Claws

Overtightening of the US monetary policy leads to indiscriminate selling of most assets, particularly high-risk long-duration ones like crypto. However, this trend will reverse in 2023.

Too aggressive monetary easing

The coronavirus pandemic in 2020 was met with a large-scale monetary and fiscal stimulus. The US Federal Reserve launched unlimited asset purchases (QE), and the federal budget deficit reached a record $3.1 trillion for the 2020 fiscal year. That supported the economy during the pandemic but laid a foundation for future imbalances. Money creation was so huge that it can be easily spotted on the long-term chart. US M2 money supply increase in 2020-21 was about as large as in the previous 10 years combined.

US M2 money supply (billion USD)

Source: Bloomberg

Most importantly, the stimulus largely remained in place in 2021 (primarily because of the extremely easy monetary policy) despite economic recovery. In 2020 the US Federal Reserve initiated a monetary policy review. Frustrated by persistently low inflation, it moved to a new approach, allowing inflation and employment to run higher. As a result, in 2021 the Fed ignored the booming economy and kept rates at zero level in order to boost inflation and prevent inflation expectations from slipping below the target.

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Be careful what you wish for

The Fed has been way too successful in boosting inflation. Huge money printing despite the very strong economy has led to much faster price growth. The US CPI reaches multidecade highs, and inflation becomes a hotly debated public issue. Ironically, it has not been anticipated by the Fed, so it has to hike rates much faster than it had been expected. In December 2021 the Fed funds rate was expected to gradually increase throughout this year and to finish at less than 1% in December. The current Fed funds rate is 2.3% and it’s expected to be above 4% in December. Also, the Fed engaged in so-called quantitative tightening, directly “burning” money by reducing its balance sheet. After panicking about too low inflation and overstimulating the economy in 2020, the Fed now panics about too high inflation and is seemingly primed to overtighten.

Fed funds rate forecasts now and as of end-2021 (bp)

Source: Bloomberg, New York Fed

Tighter monetary policy leads to an inverted yield curve, when long-term rates are lower than short-term rates because the market believes that current rates are unsustainably high and will be reduced in the future. Spread between 2-year and 10-year US Treasuries yield, commonly viewed as one of the best measures of policy tightness and leading indicators of a recession, declines to the lowest level since 2000.

Spread between 2-year and 10-year US Treasuries yield (bp)

Source: Bloomberg

USD rally

Reacting to the tight monetary policy, the US dollar rallies to multidecade highs against major currencies. Major currencies' plunge from their maximum levels is comparable with Bitcoin's drop from its 2021 high. The British pound and Japanese yen have plummeted by about 2 times from their maximum levels (in 2007 and 2011, respectively), and Bitcoin has fallen by about 3 times.

EUR/USD, GBP/USD, USD/JPY (inversed)

Source: Bloomberg

Effect on crypto

The USD rally leads to a price decline of most assets when measured in USD terms. High-risk long-duration assets like crypto and stocks of technology and biotechnology companies with small/negative current cash flows are hit particularly hard. Virtually all such assets were sold off roughly in line, almost ignoring the specific fundamentals of each one.

Performance of high-risk innovation assets (indexed at 100)

Source: Bloomberg

What’s next

The markets increasingly price in a policy mistake by the Fed, when steep rate hikes in 2022 lead only to a rate reduction starting from Q2 2023. Tight monetary policy in the next few quarters will likely lead to a recession and then lower inflation in the years ahead. The market goes as far as implying that higher inflation readings today are negative for future inflation. For example, last week on the day of the ugly US CPI report 30-year US Treasuries were largely unchanged, far outperforming shorter-term bonds and stocks.

If the Fed will be as successful in decreasing inflation as it was in igniting inflation in 2020-21, investors need to worry about deflation. "Buy long-term Treasurys, because the deflation risk — in spite of the fact that the narrative today is exactly the opposite — the deflation risk is much higher today than it's been for the past two years," said DoubleLine Capital CEO Jeff Gundlach, who is often referred to as a “Bond King”. If he’s right, that may be a big tailwind for crypto next year.


The Crypto drop this year is largely a mirror image of the 2020-21 rally, and the same is true for most other risk assets. Like too loose monetary policy in 2020-21 inflated prices of many assets above their fundamental values, too tight monetary policy in 2022 may depress prices below values implied by fundamentals and long-term trends. Investors should understand that both price moves reflect excess volatility caused by monetary policy mistakes rather than asset-specific factors.

*This communication is intended as strictly informational, and nothing herein constitutes an offer or a recommendation to buy, sell, or retain any specific product, security or investment, or to utilise or refrain from utilising any particular service. The use of the products and services referred to herein may be subject to certain limitations in specific jurisdictions. This communication does not constitute and shall under no circumstances be deemed to constitute investment advice. This communication is not intended to constitute a public offering of securities within the meaning of any applicable legislation.