NewsFlash Articles Data Fundraising BlockBeats Pro

Arthur Hayes: Bitcoin may experience a 20%-30% adjustment in March

Read this article in 24 Minutes

Currently, markets expect the Fed to initiate its first rate cut since it began raising rates in March 2021, by at least 0.25%.

Original title: "Signposts"

Original author: Arthur Hayes, medium

Original translation: Kate, Mars Finance

Editor's note: At the beginning of the new year, the SEC will make a decision on the Bitcoin spot ETF, Cancun upgrades, Bitcoin halving... These events make the crypto market in 2024 destined to be turbulent. Change never changes. With the joint efforts of many people, the "crypto" building is getting higher and higher. Facing the unknown and unpredictable 2024, BitMEX co-founder and former CEO Arthur Hayes published his observations and views on the market on medium, the full text is as follows:

All day long, I dreamed of powder. Snowy weather is the first choice. My favorite days are when gray clouds blanket the mountains, heaping fat slices of an endless supply of dry champagne powder. I know that even if I’m lucky enough to chop fresh vegetables, in a few hours the fields will be refilled with water and my diving lessons will start all over again.

To see things clearly, I hide in the woods. Bare birch and pine trees dot the glades. In this wooded white paradise, I can finally see the outlines of the snow and read my lines clearly.

The trees provide me with vision during Hokkaido’s daily snowstorms, while central bankers and politicians provide me with vision as I navigate global capital markets. While no trader can predict the future, we can observe decision trees in the face of our incompetent overload and assign probabilities to each outcome. If the probabilities the market assigns to events don’t align with our own calculations, a trading opportunity is at hand.

It’s still early days for the crypto bull market, and we can’t get carried away by our enthusiasm. With Bitcoin blocks being generated every 10 minutes, the current filthy fiat financial system is meeting its predetermined inglorious end. No matter how certain I am about this final outcome, the path to the future is unknown. We must remain vigilant and position our chips accordingly.

In short, at this stage in the cycle, I am fully allocated, meaning I sold fiat and bought crypto. I am preparing for the vicious purge of all crypto tourists in March this year. There are various signposts that lead me to the future. I will lay out my reasoning and the inflection points I will observe that will give me the confidence to first massively short the crypto market using Bitcoin put options, and then resume selling US Treasury bonds (T-bills) and buy more Bitcoin and other cryptocurrencies.

Variables

There are three variables, in the form of questions, that collided with each other in March.

When did the Reverse Repurchase Program (RRP) balance drop to near zero?

Liquidity is being injected into the financial system through the decline in the Reserve Requirement (RRP) balance. When this number approaches zero, which I define as a balance of $200 billion, the market will wonder what happens next. Another source of USD liquidity supply is needed to keep the party going.

To learn more about the mechanism of how the decline in RRP balances injects liquidity into the system, read my article "Bad Gurl".

Here is the entire historical chart of the RRP balance. The horizontal white line is $200 billion.

I believe reserve balances will hit $200 billion by early March. I arrived at this estimate by running calculations based on the rate of decline through 2023 based on several different starting points.

Will the Term Bank Funding Program (BTFP) be extended?

On March 12, failed banks must find cash to exchange for Treasuries and other eligible bonds that they have repurchased from the Fed. Ultimately, this is a call for bad girl Yellen. The market will have started to wonder a few weeks ago whether banks will continue to get this lifeline.

The original BTFP process was that banks offered $80 worth of Treasuries on the open market but received $100 in cash. When the program ended, the banks had to return the $100 and then get the original Treasuries. If the cash is given to a fleeing depositor, how will the bank get the cash without selling more shares or issuing high-yield bonds?

To understand the reasons for the creation of BTFP and its impact on the speed and extent of fiat currency depreciation, please read my article "Kaiseki".

Will the Fed cut interest rates?

The Fed's March meeting will end on the 20th of this month. Currently, the market expects the Fed to initiate the first rate cut since it began raising interest rates in March 2021, by at least 0.25%.

This is a table of Fed Funds futures implying the probability of a rate hike at a future Fed meeting. As you can see, as of January 3, the market is pricing in a 75% chance of a 0.25% rate cut.

These variables are interdependent. The order of events is important because it will affect the market's assumptions about how much USD liquidity the Fed and the US Treasury will or will not provide in the future.

If… Then…

Now, we have to assign probabilities to the different paths and predict how the market will react.

The speed of the RRP decline

If the reserve requirement ratio is reduced to near zero by early March, financial markets will begin to decline. Remember when the surge in US Treasury yields coincided with the stock market crash? The only reason bonds had such a spectacular rally starting on November 1st was the release of the quarterly Treasury refund document that day. This now must-read report confirmed that the Treasury would shift more borrowing to the short end of the yield curve. As Treasury supply increases and yields rise, money market funds (MMFs) will be financially incentivized to use cash parked in RRPs to buy Treasurys. All else being equal, a decline in RRP balances increases liquidity in the system. This is what we have seen so far and is the reason for the sharp rise in global bond and stock markets.

The white line is the 10-year Treasury and the yellow line is the difference between the 10-year and 2-year Treasury yields. As you can see, yields steepened as they peaked in late October, meaning that both the white and yellow lines rose simultaneously. A vicious bond short squeeze began in early November and yields plunged.

Without other new sources of USD liquidity, bonds, stocks, and I believe crypto will also take a hit. I will elaborate on this later in the tactical trading section, but I will be buying a sizable Bitcoin put option position in the meantime.

We have no way of knowing how quickly, if at all, the RRP will decline. Therefore, I will be keeping a close eye on the pace of change. If there is a significant deviation from my predictions, I will adjust my trading strategy accordingly. Regardless, I am heavily invested in crypto for the second half of 2023, and I believe that now through April is a no-go from a risk-on perspective.

BTFP

2024 is an election year and the people of Pax Americana are tired of banker bailouts. Therefore, I believe Yellen will not renew the BTFP in order to show confidence in the strength of the US banking system. However, once several large enough non-TBTF banks are forced into receivership due to equity falling to near zero, exhausting the necessary regulatory capital, Bad girl Yellen will hang up her heels and wear knit slippers, thus becoming Grandma Yellen. Grandma Yellen will give the printed money to her wayward banking grandchildren in the form of new BTFPs.

The combination of the lack of liquidity created by the RRP and the lack of money printing to cover the bond losses on the non-TBTF bank balance sheets will devastate global financial markets. The market must inflict pain on financial asset holders to force the Fed and Treasury to start printing money again. This is a relevant moment. All assets, including cryptocurrencies, will fall together as markets hyperventilate at the prospect of free markets functioning again and cleaning up bankrupt banking institutions.

March FOMC Meeting

The BTFP expires on March 12th and the Fed announces its rate decision on March 20th. There are 6 trading days between these two critical decision points. If my prediction is correct, the market will bankrupt some banks during this time, forcing the Fed to cut rates and announce the reinstatement of the BTFP.

Technically, the US Treasury cannot lend to banks, which is the Fed's responsibility. But suppose the Fed accepts collateral worth less than the dollars provided, and thus suffers losses. In this case, these losses flow to the Treasury, and ultimately, the US taxpayers as the Treasury must borrow more to cover the Fed's losses.

Bitcoin will initially fall sharply along with the broader financial markets, but will rebound before the Fed meeting. That’s because Bitcoin is the only neutral reserve hard currency that is not a liability of the banking system and can be traded globally. Bitcoin knows that when things get bad, the Fed always responds with an injection of liquidity. It may be called the new thing and confuse those who get their news from TikTok, but rest assured, Bitcoin knows that printed money, no matter what form it takes, is printed money. Therefore, Bitcoin will rise significantly before the Fed finally capitulates and restarts the printing presses.

The Other Side

If I’m wrong, here’s what magical happens:

1. The RRP will slowly decline, and this liquidity will continue to support financial markets through the end of the second quarter.

2. Yellen will communicate that the BTFP will be extended by March 12.

3. By then, the Fed’s March meeting decision will become irrelevant. Whether it cuts, keeps rates unchanged, or raises them, the net effect is still stimulative based on any of the above outcomes, plus all the other ways the Fed and the Treasury are adding dollar liquidity to the market.

If the RRP declines more slowly than expected, I will not have established my short position in early March. Then, the date when Yellen indicates that the BTFP will be renewed is when I will exit from not trading. I will resume selling Treasuries for Bitcoin and other cryptocurrencies.

Tactical Trading Decisions

Let's go back to the basic scenario of the RRP being exhausted in early March, the BTFP being cancelled on the 12th but reinstated on the 20th and the Fed cutting rates. Now I will expand on my trading plan a bit.

Bitcoin Put Options

As many of you know, I have a diversified crypto portfolio. My largest positions are in Bitcoin and Ethereum, which make up 70% of my portfolio. The other shitcoins I hold are much less liquid, and especially the liquidity of these shitcoin derivatives is very poor. Therefore, if I want a liquid macro crypto hedge, I have to use Bitcoin derivatives. I use the word "hedge", but this is a trading position. The trade setup I am describing only takes two weeks to resolve. Because this is a trade, I will use options that allow me to know my maximum loss a priori, the premium I buy the put option. An additional feature is that I do not need to monitor liquidation levels like I do when trading perpetual swaps or futures contracts.

I expect Bitcoin to experience a healthy 20% to 30% correction from the levels reached in early March. This shock could be much worse if US-listed spot Bitcoin ETFs had already started trading. Imagine if hundreds of billions of dollars of fiat flowed into these ETFs in the future, Bitcoin would be over $60,000, close to the 2021 all-time high of $70,000. I can easily see a 30% to 40% correction in the stock market due to the impact of USD liquidity. This is why I cannot buy Bitcoin until the decision date in March has passed.

I feel like I am a good trader when I am focused. I will try to top the market in late February and then buy a sizable put position. I will buy a put option that expires on June 28th. I don't want the March 29th expiration because I will be in the position in early March. High negative theta will likely overwhelm any delta, gamma, and vega gains and losses. The longer the expiration date, the higher the cost, but the premium will not drop as quickly as it would if the expiration date was more than a quarter.

I will set a maximum loss, which will be quite large relative to my standard trading position, and then buy put options. To get some nice gains on these puts, I will select a 20% to 25% strike based on the current June quarter spot futures contract price.

Exiting a Position

Many traders, especially options traders, nail their entry points but struggle with their exits. Since option payouts are path dependent, if you wait too long to exit your position, you may think the market is correct but still lose money. Every day I hold these puts, I am losing money. If my prediction is correct, the market will begin to meaningfully correct around March 12th. Between the 12th and the 20th, I need to try to pick the bottom and exit my position, hopefully at a profit. If my policy judgment is correct but Bitcoin holds or rises, I must immediately exit my put position.

The Bull Run Continues

By the end of March, we will be back to normal. Bad girl Yellen and her duck Powell will once again confirm that they will stop at nothing to preserve the fiat solvency of the Pax Americana financial system. With this brief market turmoil over, cryptocurrencies may surge again amid speculation about the impact of the upcoming Bitcoin block reward halving. Therefore, I will resume selling US Treasuries for Bitcoin and other cryptocurrencies

Curveballs

This article is entirely focused on the decisions of the two managers of the Pax Americana financial system. All "democracy" and things are still managed by two unelected bureaucrats. Regardless, there are other key players in the kabuki theater of the fiat financial system.

China

The Taiwan elections may result in a pro-China candidate winning, and then Xi Jinping will turn on the RMB printing press. The influx of RMB credit into global markets overwhelms any problems in the US banking system, causing cryptocurrencies to continue to move higher, even if the RRP runs out and the BTFP is not updated. The trade setup would then become much less attractive in terms of risk vs. reward, and I would probably choose not to buy any puts, and instead buy more cryptocurrencies.

Japan

The Bank of Japan (BOJ) is slowly allowing Japanese Government Bond (JGB) yields to rise. If JGB yields continue to rise, it will be economically incentivized for Japanese companies, pension and insurance funds, and households to repatriate funds. They will sell US Treasuries and buy JGBs because onshore bonds offer higher yields. If this trend continues, I will be sure to bless you readers with an article describing this phenomenon in more detail. Given that Japan is the largest holder of US Treasuries and the largest international creditor in terms of its net international investment position, actions by the Japanese private sector could put significant upward pressure on US Treasury yields above 10 years.

This is data from the IMF that estimates Japan’s net international investment position at $3.3 trillion.

This pressure could build before early March and force Fed Chair Janet Yellen to do more money printing. If so, I may not even have a chance to take this trade, because well before mid-March, Yellen would have updated the BTFP and introduced some newfangled ways to print money, not call it money printing. One of the alternatives is a plan the US Treasury is cooking up to buy expired long-term US Treasuries by issuing more short-term bills. This is a soft version of yield curve control, which she calls a repo program. There was an explanatory paper on this last year, if you want to read it carefully, I linked it here.

Downside Risks

With central banks printing money in various forms in the new year, plus the expected listing of spot Bitcoin ETFs in the US and Hong Kong, the downside risks to Bitcoin are there. It is not difficult to be bullish now. I like to buy stocks that do well when situations that the market thinks are impossible are considered possible. From a trading perspective, the risk reward is better to take non-consensus views using these signposts representing binary outcomes. Maybe I will be wrong in the end. But if my expected value is correct, my profit will be much greater than if I followed the crowd.