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Not US Debt Default, But Fed Path to Drive Crypto

Something had to break from the US Federal Reserve's aggressive rate hikes over the past year or so. And it did.

Photo by Alice Pasqual / Unsplash

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The US banking crisis directly results from rising interest rates and, in turn, falling Treasury prices, which hurt regional banks' capitalisation.

"Just to put the Fed's action into context: a rate decision usually takes at least two quarters to transmit fully into the wider economy. In the current tightening cycle, jumbo rate hikes were a common theme - which suggests the real scepticism of the impact of decade-high rates is only the tip of the iceberg so far," said a chief investment officer at a large US asset management firm in Boston.

"What we really need to see is how much this will weigh on the broader economy as rate hikes don't work in silos," added the CIO.

As part of its measures to shore up liquidity, US lender PacWest Bancorp decided to sell a $2.6 billion portfolio of real estate development loans at a discount. PacWest Bancorp was one of the US lenders engulfed in the regional banking turmoil.

In a statement released on Monday, Kennedy-Wilson Holdings announced that it would acquire the pool of 74 loans for an estimated $2.4 billion. It further said that the buyer would take up all future financial commitments for the loans totalling around $2.7 billion.

Since March 7, when news of the failure of Silicon Valley Bank and other regional lenders shook comparable companies across the United States, shares of PacWest have fallen over 80%.

The firms' strong exposure to real estate financing and sinking deposits as consumers sought higher-yielding alternatives caused investors to worry about the firm's financial stability.

While the banking crisis led to a softening in the Fed's tone despite inflation still exceeding the central bank's target rate, predictions are firming for another hike in June.

Indeed, whispers have become loud calls for more from the Fed after a US inflation measure remained stubbornly elevated.

Fed officials, too, have come out and said more is needed to bring inflation under control.

James Bullard, president of the Federal Reserve Bank of St. Louis, has voiced support for two further interest rate hikes in 2023, while Neel Kashkari, president of the Federal Reserve Bank of Minneapolis, has suggested that if the central bank pauses next month, it should signal tightening isn't finished.

Bullard's comments on Monday contradict Chair Jerome Powell's warning from the previous week that the Fed may hold fire at their June 13-14 meeting to evaluate the impact of prior hikes on price pressures in light of stresses in the banking sector.

Kashkari seemed to mirror the Fed chair's view.

Interest rate futures indicate that investors presently price in a 22% likelihood that policymakers will raise rates by a quarter point next month.

Now, What Does That Have to Do With Crypto?

Investors are not concerned about the impact of the US standoff on debt deal talks.
But their bets on how cryptos will perform in the near term are driven more by what the Fed will do and signal.

The banking crisis boosted digital assets as an alternative asset class for investors. But the Fed's to-and-fro on their communication has somewhat halted the rally in cryptos.

"No clear play in sight for any asset class at the moment. The Fed is a bigger story for digital assets as investors expect the US to reach a debt deal. And even if the US defaults, that would boost digital assets," said the Head of Investment Strategy at an asset management firm in New York.

"And until there is clarity on expectations firmly for rates to come down by the end of the year eventually, the see-saw in global financial markets, including cryptos, will be the norm," he added.

Big names in the bond market are sounding the alarm that the recent wild swings in US Treasuries are only the beginning of a new period of volatility that will persist until central banks succeed in taming inflation.

A widely followed index of bond market volatility has already reached levels not seen since the Global Financial Crisis.

Risks in the banking sector and the debt limit conflict compounded the previous two years of erratic interest rate fluctuations while the economy recovered from the epidemic.

This is the new reality that investors in these fixed-income giants, who handle trillions of dollars between them, will face for years.

They say this is due to the Fed's shift into inflation-fighting mode after buying trillions of dollars of debt since 2009 to stimulate growth. This move has helped reduce volatility and sparked a massive shift towards passive bond investing.

"We've gone back to the future – back to normal — which makes sense as the Fed has taken its thumb off the scale," Harley Bassman, who created what is now known as the ICE BofA MOVE Index, a widely used gauge of implied volatility in Treasuries, while at Merrill Lynch in 1994, according to a Bloomberg report.

He's now at Simplify Asset Management.

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