By Head of Treasury, Ang Kok Wee
Past Week’s Performance Dashboard
The Isreal-Hamas conflict has now entered its second week. The concern now is when and how Israel is going to launch a full-scale ground offensive in Gaza, which will have destabilizing consequences to the region. Despite intense US-led diplomatic efforts, there has been no progress and Palestinians remain trapped within Gaza as the humanitarian crisis develops.
At present, the situation seems to involve a great deal of brinksmanship. Iran has issued a warning that a multi-front conflict, involving Hezbollah from Lebanon, may become unavoidable if such an offensive occurs. Concurrently, President Biden is scheduled to embark on visits to Israel and Jordan this week, seemingly with the intention of showcasing a united front with Israel and mitigating the escalating tensions with Iran.
Sea of Calm
Amidst this geo-political backdrop, US equities and the rates market have held up well. S&P500 is 0.3% higher than a week ago while US 10-year Treasury yields have also recovered and are 20 basis-points higher, currently at 4.85%. The CBOE VIX Index, otherwise known as the fear gauge, is currently at 17.89. It had moved higher in the wake of the conflict, but has reverted to similar levels prior to the event (Fig. 1). Other markets suggest a little more concern, with gold and oil each rising almost 6% since the attacks.
The softening of Fed language continues to be the main factor for general market resilience. The September FOMC Minutes, released on October 11, had two significant mentions with the word “carefully” to describe the Fed’s outlook. In contrast, there were previously no mention of such in the August FOMC Minutes:
- All participants agreed that the Committee was in a position to proceed carefully and that policy decisions at every meeting would continue to be based on the totality of incoming information and its implications for the economic outlook as well as the balance of risks.
- A vast majority of participants continued to judge the future path of the economy as highly uncertain. Many noted data volatility and potential data revisions, or the difficulty of estimating the neutral policy rate, as supporting the case for proceeding carefully in determining the extent of additional policy firming that may be appropriate. Source: https://www.federalreserve.gov
Past conflicts in the Middle East suggest that if current tensions escalate, it has the potential to disrupt the global economy and push it into a recession, particularly if more countries become involved. The ongoing crisis in the Middle East may further prompt the Federal Reserve to contemplate this balance of risk.
A decent start to the US earnings season also provided some tailwinds for US equities despite a mixed bag of results from big banks. Both JP Morgan and Bank of America beat forecasts while Goldman Sachs fell short of expectations. We are in the early stages of the earnings season however, and more remains to be seen.
Potential Market Catalyst This Week
Fed Vice Chair Philip Jefferson and Chair Jerome Powell are due to speak on Thursday and Friday, respectively. As with several Fed colleagues who have spoken in the past week, the message is likely to be consistently dovish.
There is no other significant data for the week ahead.
Some key company earnings announcements:
October 18 (Wednesday) -Tesla (TSLA), Netflix (NFLX) after market close
October 24 (Tuesday) – Microsoft (MSFT), Alphabet (GOOGL) after market close
On October 16 (Monday), Bitcoin experienced a sudden 9% price surge within a short half-hour period, spurred by an unconfirmed news leak from Cointelegraph regarding Blackrock’s potential Spot Bitcoin ETF application. Short covering drove Bitcoin’s price to a high of USD 30,500. While most of the gains later retraced, Bitcoin has managed to grind back to around USD 28,450 level, almost 4% higher than a week ago.
In our previous commentary, we highlighted the possibility that the recent “flight to quality” observed in the Gold market might eventually filter through to Bitcoin, which is sometimes referred to as “Digital Gold.” While we would like to see that “safe haven” quality of Bitcoin shine through, we remain skeptical about its past week’s performance and believe it will continue to stay range bound. This recent bout of volatility was driven by fake news and exacerbated by short covering. It has been reported that approximately USD 100 million worth of liquidation (mostly in the form of short Bitcoin perpetuals) occurred. In an absence of new development, fading this short-term rally may be opportunistic. Technical ranges for Bitcoin and Ethereum are (Fig. 2):
Understandably, Bitcoin implied volatility is higher compared to a week ago (Fig. 3):
We remain sanguine of Securities and Exchange Commission’s (SEC) approval for spot Bitcoin ETFs which, if approved, could potentially bring in a substantial amount of institutional money into the Bitcoin market, increasing its price and dominance.
Given the potentially explosive impact of such a decision on the price of Bitcoin, we recommend that you mark down the various SEC approval datelines (Fig. 4):
Overshadowed – Ethereum Implied Volatilities vs Bitcoin
This week we also explore the phenomenon of implied volatilities of Ethereum options versus Bitcoin options. For any given option structure (specific strike and tenure), implied volatility is the single most important determinant of the cost of an option. In other words, it can be used to measure how expensive an option is.
Over the past year, we observe a consistent decline in both Ethereum and Bitcoin implied volatilities. This can be attributed to the fact that the cryptocurrency markets have experienced relatively stable price ranges (e.g. Bitcoin trading within the USD 25,000 to USD 30,000 range since March 2023).
Additionally, investment markets have been actively seeking yield generation by engaging in the sale of volatility. Compared to Bitcoin, the supply of volatility (selling Ethereum options) has been even higher due to two main reasons:
- Ethereum’s transition from PoW (proof-of-work) to a PoS (proof-of-stake) model back in Sept 2022 (known as the ‘Merge’)
- Implementation of the Shanghai Fork in April 2023
The change in Ethereum’s blockchain model has triggered an increase in staking activities among validators. This has transformed Ethereum into a source of passive income for a significant portion of its holders, with staked Ethereum estimated to constitute around 16% of the total supply as of June 2023 (Fig. 7). Consequently, liquidity of Ethereum has been adversely affected.
At the same time, with Ethereum evolving into a passive asset primarily held by validators, there exists an incentive to enhance the yield returns by engaging in the practice of selling call options with high-strike prices against the asset, essentially executing covered calls.
This constant supply of option sellers appears to be a major factor to drive Ethereum implied volatilities lower. This trend looks to continue for the foreseeable future, and we expect Ethereum options to remain cheaper than Bitcoin options on a relative-value basis.
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