Weekly Kabezo Newsletter

Crisis Averted?

Kabezo's Newsletter offers an in-depth overview of the markets after another week of significant developments.

A stay of execution, for now.

This week’s main event for macroeconomic data came on Friday with the release of the Personal Consumption Expenditure (PCE) Core Price Index by the U.S. Bureau of Economic Analysis.  The preferred inflation gauge for the U.S. Federal Reserve came in lower than consensus forecasts at 0.3% month-on-month.

Markets for stocks, bonds, and cryptocurrencies responded with an orderly rally.  The bellwether S&P 500 index ended the week +3.2%, and the yield on the benchmark U.S. 10-year Treasury dropped to 3.4%.

Presumably, the cautious optimism in markets for risk assets assumes that moderating inflation will give the Fed leeway to bring an end to this cycle of rate rises.  Big-brain macro pundit Mike Green published an interesting chart of the correlation between the Fed’s Global Supply Chain Pressure Index and forward core CPI expectations that suggests inflation relief is indeed on the way. 

But a levelling off of the Fed Funds policy rate at 5% will not be enough to stem the liquidity crisis facing regional U.S. banks. 

To repeat an oversimplification of the crisis:  over the last few years, banks took in a flood of deposits, paying almost nothing in yield to depositors, and bought “risk-free” government bonds.  The last 12 months of rate rises by the Fed have resulted in significant losses in those bond portfolios while at the same time, deposits are being swiped by 4-week T-bills at 4.7%, Fed Funds at 4.75%, and the Reverse Repo Rate (RRP) at 4.8%. 

Where can banks borrow to fund the loss of deposits?  The Fed is lending via its new BTFP program at 4.85% 

Banks that need liquidity can normally borrow overnight against their bond holdings.  But with bond portfolios deeply marked down, the collateral is worth less, and the Fed has needed to step in where market participants will not and lend against discounted collateral at par.  Banks that did not hedge interest rate risk could easily be funding bond positions yielding 1.5% with BTFP funding of 4.85%.  That is not a sustainable business.

Is anyone that desperate?  Judging by the $363 billion jump in the Fed’s balance sheet, it certainly looks that way.

In the last two weeks, the BTFP has reversed 58% of the reduction in the Fed’s balance sheet over the last 12 months.

Has it ended the crisis?  The tentative answer to that question might be the true main event of the last week.  With no bank failures since March 12th, and a slightly less threatening inflation reading, perhaps there is hope that the Fed has contained the crisis and is finished with this cycle of rate rises. 

A lack of bank failures?  Seems like a very low bar to clear for a stock market rally.    

For crypto, the rally makes more sense in somewhat the same way that bidding par for T-Bills makes sense.  There is no default risk in owning Bitcoin or T-Bills.

Three banks have suffered runs on deposits so far.  This decline in confidence could be one of the reasons there were $2.4 billion of bids at par in the 4-week T-bill auction this week. 

For the third week in a row, bidders are less concerned with the return on capital than the return of capital.    

Bailouts of banks and other financial entities, a recurrent theme in modern financial crises, are subject to the whims of bureaucrats.  The policy response most often includes the creation of more money.  In a narrow sense, this crisis has already delivered that via the $363 billion of BTFP funding.  It is interesting that Bitcoin, the original cryptocurrency, born of the 2008 financial crisis and notable for its sound money properties, is leading the crypto rally and has increased its market cap dominance to 46%.

What is driving the Bitcoin narrative?  The usual stuff.

  •  Most of the access to the U.S. banking system by exchanges and other crypto-focused businesses has been closed off over the last month. 

  • Custodia Bank, which is seeking to provide such access, was denied membership in the Federal Reserve System. 

  • A “Wells Notice” of impending enforcement action was delivered to exchange operator Coinbase. 

  • Terra Luna creator Do Kwon arrested in Montenegro. 

  • FTX founder Sam Bankman-Fried faces new charges of violating the Foreign Corrupt Business Practices Act for an alleged $40 million bribe to Chinese officials. 

  • Leading exchange operator Binance and founder Changpeng Zhao (CZ) face a civil suit in U.S. District Court for multiple alleged violations of CFTC regulations. 

  • Following the approval by a bankruptcy judge for the sale of assets from bankrupt crypto lender Voyager Digital to Binance.US, a Federal Judge granted a stay of that order pending appeal by the government. 

  • Exchange operator Bittrex announced a closure of U.S. operations citing “regulatory uncertainty”. 

  • The U.S. government sold BTC 9,861 of the BTC 50,491 it seized from the Silk Road darknet market netting proceeds of $215,522,416.83 and plans to sell the balance in four tranches.

Against this is the deflationary value proposition of the simplest of digital bearer assets.  This is the environment that is attracting more buyers than sellers.  Bitcoin is up 4% on the week and more than 70% this year.  

With a capitalization of $542 billion, Bitcoin currently ranks 12th among the largest companies and commodities.  

The price of an asset that size cannot be kicked around like an alt-coin or meme stock (although short sellers of TSLA might disagree).  Nobody knows who the bidders are.  But it is less likely to be crypto bros than institutions. 

According to an 8-K filing with the SEC, Microstrategy (MSTR) was one of those.  In the filing, MSTR revealed that it paid off a $205 million loan from Silvergate Bank with the proceeds of a sale of the company’s class A common stock that netted $339 million.  It also let slip that the company bought an additional BTC 6455 for $150 million between February 16th and March 23rd.  MSTR is now holding BTC 138,955 at an average purchase price of $29,817.  Marking at a BTC price of $27,000 that hoard of tokens is worth $3.75 billion.  Yet MSTR has a market cap of only $3.4 billion.  I guess everything is different in crypto.

The recent launch of cryptocurrency custody solutions by TradFi giants such as BNY Mellon and Fidelity indicates that there is institutional interest beyond giga-chads like MSTR Executive Chairman Michael Saylor.  The price action of BTC and ETH seems to support that idea. 

What is supporting BNB?

Yet another Binance obituary was written this week in the form of the CFTC’s lawsuit against the dominant cryptocurrency exchange.  Like many other legal documents in crypto litigation, the complaint was filled with lurid details.  For example, the allegation of inadequate AML KYC compliance was peppered with quoted text messages that appeared to show light-hearted banter about terrorist financing among Binance executives. 

Bad for the Binance-associated BNB token, right?

The BNB market response to the release of the complaint was a 5% drop in price, maintaining year-to-date gains of 26%.  It does not seem that BNB users are fazed. 

Why not? 

Regarding investor interest, BNB is the opposite of BTC and ETH.  Institutions do not want anything to do with BNB.  The token floats on top of an enormous retail user base that is mostly outside of the U.S.

While BNB Chain dApps garner relatively little treatment from crypto media outlets and institutional research reports, the user base is loyal and by far the biggest.  While Ethereum unique addresses total 226 million, the count on BNB is 276 million. 

According to DappRadar, unique active users of BNB decentralized exchange PancakeSwap at 1.32 million were more than double that of the next largest DEX, Uniswap V3 on Ethereum.  This has long been the case.  And if users find the details of the CFTC’s complaint interesting, it looks like the suit will not change their habits.  BNB is providing access to an alternative financial system.  Unlike the big American high-frequency trading shops mentioned in court documents, BNB Chain users do not appear chastened by the CFTC.

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