Resilient US Economy, Dovish Fed, and Bitcoin’s Roaring Comeback Define 2023 Financial Landscape

By Ang Kok Wee, Head of Treasury

Past Week’s Performance Dashboard

  • After a brief correction last week, Bitcoin has returned to posting weekly gains (+3.2%). Robust demand negated last week’s $40,400 flash-crash and established a key support level there.
  • Central banks of the UK, EU, and Switzerland kept their respective monetary policies unchanged in the past week as expected and without much fanfare.
  • The US Federal Reserve (Fed) also kept its key rates unchanged but surprised the markets with an extraordinary dovish outlook on interest rates.
  • US equities markets surged. Broad-based buying across sectors in equities pushed the Dow Jones Index (DJI) to its all-time high of 37,557.90. The S&P500 Index is 1.5% shy of its own record of 4,838.59.
  • The bond market rally continues as US 10-year Treasury yields come under pressure. It is currently at 3.93%.
  • Bank of Japan (BOJ) maintained its ultra-loose monetary policy yesterday, holding negative interest rates and declining to hint at a timeframe for phasing them out. This lack of hawkish signals sent the Japanese Yen sliding 1% against the US Dollar, erasing some of its recent gains against a weakening greenback.

Dovish Fed

Last week, the updated Fed Dot plots sent ripples through the market. While falling short of the market’s expectation of steeper cuts (see Fig. 1), it projected some 75 basis-points reduction to 4.625% by end of 2024. This marked a clear shift towards dovishness from Fed Chair Powell, who just two weeks earlier cautioned against premature talk of easing rates.

Fig1 Updated Fed DOT Plots vs Fed Funds Futures Market Source Bloomberg

With the Fed pivot firmly in place, the buying frenzy continues to fuel the ongoing Santa market rally. Whether this momentum can continue into next year remains unclear. A compelling case can be made from either side of the bull or bear camp, a debate that we will revisit in the new year.

2023 in Review

As markets seem determined to end the year on a high, we take this opportunity to review some key themes and events that contributed to shaping the financial landscape for both global financial as well as crypto markets in this week’s special edition. The curated list includes:

  • Unexpected Resilience of the US Economy
  • Yield Curve Volatility and Sectoral Stress
  • Fed Pivot
  • Bitcoin’s Recovery and Outperformance
  • Crypto Regulatory Development

Unexpected Resilience of US Economy

Recession’s No Show.  Despite facing the headwinds of the Fed’s most aggressive rate hike cycle in four decades, the US economy navigated a remarkable course in 2023. Inflation trends moderated at an even pace while the labour market showed surprising resilience, maintaining low unemployment rates and healthy wage growth. US GDP continued to expand under such Goldilocks environment, particularly in the second half of the year, and subsequently outperformed its G10 peers.

Yield Curve Volatility and Sectoral Stress

Regional Banks. Aggressive monetary tightening by the Fed caused the shorter maturity yields to surge over longer dated ones, causing an inversion of the yield curve. In March, the 3-month Treasury yields rose to 5%. The first victims were less well-capitalised US regional banks. A squeeze in deposit base and subsequent liquidity crunch ensued and led to three banks – Silicon Valley, Signature, and First Republic – to collapse in quick succession.

In a swift response to limit the contagion, the Fed established the Bank Term Funding Program (BTFP). This one-year initiative enabled regional banks to deposit their long-term US Treasury holdings with the Fed at par; essentially absorbing their immediate mark-to-market losses on these securities. This effectively shored up short term liquidity for the banks while the Treasury market recovered.

Commercial Real Estate. Challenges intensified as the longer end of the yield curve adjusted to align with the Fed’s “higher-for-longer” policy narrative. The commercial real estate industry, already strained by high vacancy rates and diminishing funding liquidity, faced further difficulties. The increase in longer-term yields made it particularly challenging to finance business models that relied heavily on leverage. By October 2023, this mounting pressure was evident in the performance of the Dow Jones Real-Estate Index, which saw a significant decline of 35%.

While the aforementioned pockets of stress were challenging, none succeeded in creating a contagion to derail the broader economy. That being said, the fluidity of the yield curve had still been a constant source of nerves. The fact that US 10-year Treasury yields today are almost exactly where it was at the beginning of 2023 masks the highest volatility it has witnessed in the bond markets in the past decade (Figs.2 and 3).

Fig 2 US 10 year Treasury Yield in 2023
Fig 3 US 10 year Treasury Yield Volatility basis pointday

Fed Pivot

Following a 21-month period of aggressive anti-inflation measures through substantial rate hikes, the Fed is now signalling confidence in achieving a “soft landing” for the economy.

This indicates a potential shift to cutting rates, possibly starting around next March. However, this anticipated change comes with the usual caveats. The Fed’s subsequent decisions will be contingent on economic data and the deemed impact of their policy adjustments on inflation. This nuanced strategy for the Fed ultimately aims to normalise monetary policy without reigniting inflationary trends.

Bitcoin’s Recovery and Outperformance

Winter’s Thaw. The FTX implosion in November 2022 was a chilling reminder of crypto’s volatility. It marked the low point of a year-long “crypto winter,” but what followed was not just survival, but surprising strength.

2023 emerged as a season of introspection and growth for the industry. This year has also been marked by rebuilding as an industry, improving transparency, and aligning with best practices and compliance standards to build towards a more resilient ecosystem.

The first 9 months saw glacial trading activity. The volatility of Bitcoin and Ethereum fell to their all-time lows, at times registering only 1% daily moves. Ironically, this would rank crypto as less volatile than an equity like Tesla (TSLA).

Despite the overall crypto trading slump, Bitcoin’s value made a significant recovery as it emerged as the “safe haven” play within the industry. The US regional banking crisis even saw investors fleeing to Bitcoin due to temporary issues with the USDC stablecoin. Fear of the unknown and doubt (FUD) surrounding Ripple’s XRP and Ethereum further fuelled this “flight to safety,” pushing Bitcoin’s market dominance back to April 2021 levels (54% by October 2023).

Bitcoin Spot ETF Applications. The biggest catalyst yet for trading activities to return to the crypto market would have been the expectations of a Bitcoin Spot ETF approval. Crypto adoption continues to climb, with reporting 575 million crypto owners globally. The integration of cryptocurrencies into mainstream finance is expected to further boost this adoption. 2023 has been a pivotal year in this regard, where there have been no fewer than 10 applications for Bitcoin Spot ETF filed with the US Securities and Exchanges Commission (SEC). Some of these applicants are heavyweights in the funds world, among them Blackrock and Fidelity. Bitwise, best known for creating the world’s largest crypto index fund, is also among the list of applicants. It is highly anticipated that some approvals will be granted as early as January 2024.

Bitcoin’s annualised return for 2023 has been nothing short of spectacular, with 155% year-to-date returns, and only to be outshone by AI-narrative-driven Nvidia (+240%) and Meta (+191%). Its multi-year track record remains hard to beat (Fig. 4).

Fig4 Bitcoin Multi Year Annualised Returns in the Past 10 Years vs Other Asset Classes Data updated as of December 19 2023

Despite these positive developments, we believe the market’s recovery is not yet complete. While the crypto total market’s capitalization has seen a significant increase, doubling from USD 800 billion at the beginning of the year to USD 1.6 trillion, it still falls short of its peak, which was nearly USD 3 trillion in 2021.

Crypto Regulatory Development

While 2023 witnessed crypto markets thawing after a harsh winter, it also became a courtroom battlefield for the industry’s future. Two crucial rulings stand out:

Ripple’s Victory – In July, a judge threw a lifeline to Ripple. The court ruled that the SEC had not adequately defined XRP as a security, significantly weakening their claim that all non-Bitcoin tokens fall under their jurisdiction. This decision set a critical precedent, potentially limiting the SEC’s reach in the broader crypto universe.

Grayscale’s Triumph – October saw another landmark victory for crypto with a court ruling in favour of Grayscale’s lawsuit against the SEC regarding their rejected Bitcoin Spot ETF application, and subsequent SEC’s decision to not challenge the court’s ruling. This works in favour to fortify the Spot ETF approval case.

2023 also witnessed closures in the form of court trial and subsequent conviction of ex-FTX owner Sam Bankman-Fried, as well as Binance’s settlement with the US Department of Justice and the prosecution of Binance owner CZ Zhao.

In a year full of legal triumphs and challenges, we at Nodeam believe that the impact and consequences for the crypto industry’s future is for the better, as the industry attempts to evolve into a framework that is more palatable for regulators and consequently, the public at large.

May everyone experience a season filled with peace and joy! A heartfelt thank you for your friendship and support of Nodeam.

 See you in 2024!

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