Paribus : Conflicting Narratives

If the past year has taught us anything it’s that no one has a crystal ball when it comes to predicting future moves in the crypto market. Macroeconomic factors and black swan events have time and again overpowered technical analysis.

This week China will celebrate the Lunar New Year and move from the year of the Tiger into the year of the Rabbit. Already there are several confusing and sometimes conflicting narratives as to what the coming year will bring.

Many commentators are expecting 2023 to be beset by continued disruption in China. The narrative is that there will be a third wave of covid infections when people return to work at the end of January following the New Year festivities. At the same time, there’s a narrative that infections are out of control and that China is massively under-reporting its number of cases.

Based on the many conversations we’ve had with people from several of China’s main cities, the narrative that seems correct is that cases are being under-reported. Everyone we spoke to has either recovered from covid recently or is infected with the virus. The same is true for all of their colleagues and friends.

If this is typical of infections throughout China it means they will achieve herd immunity by the end of January which would rule out a third wave and increase the velocity with which their economy starts to recover. Markets are already pricing in this increase in economic activity, leading to some of the recent rises in stocks we’ve seen.

Naturally many in crypto focussed on last week’s gains, but they appear to have missed the corresponding increase in liquidity in the stock markets. Last week the MCSI Asia-Pacific index hit levels 21% higher than its October lows. The Hang Seng index hit levels 47% higher than its October lows. Meanwhile, the Nasdaq Golden Dragon China Index surged 70% higher than its October lows.

The reason for these increases is largely due to hedge funds investing aggressively in Chinese stocks after having come to the same conclusions we have, that the covid epidemic in China will be deep but short-lived. The present situation appears to be the result of President Xi’s intentional policy to remove restrictions ahead of the New Year so that covid could run through the population at a time when their industries enter a seasonal slowdown.

While China’s economic recovery is bullish for Asian stocks and international companies with operations in the country it also poses a threat to inflation. Increased activity in China means greater demand for commodities and energy which may push prices up and have a knock-on effect on US and European inflation figures.

Such an outcome could delay any pivot by central banks and increase the likelihood of a tougher recession ahead. This is where narratives get confused and demonstrates why the first half of 2023 looks set to be volatile.

Although it’s a welcome relief for many in crypto to see some green candles of hope, it’s imperative to remember that we’re just a small boat in the vast ocean of global finance. Whatever the charts may show these have repeatedly broken down in the face of much larger macroeconomic shocks.

Another factor that seems to have been underreported is that January is a time when there is usually an increase in liquidity for risk-on assets. As we explained in a previous article many investors’ portfolios are rebalanced at the end of December to show high allocations in low-risk assets. In January they once again rebalance their portfolios to take on higher-risk assets. As such, we see an outflow and inflow of liquidity into the markets across both months.

It’s likely that the cryptomarket will continue to rally until the next FOMC meeting at the end of January where it’s widely expected they will raise interest rates by 25 basis points, or 0.25%. It’s also probable this will be accompanied by a stern warning from the chair of the Federal Reserve, Jerome Powell, that they will continue to raise rates aggressively if they have to. As markets have now priced in a rebound in China’s economy and falling inflation in the US and Europe, anything that casts doubt on that positive outlook will cause them to fall once more.

Despite all the hopium on YouTube at present, it’s likely that there won’t be any change of direction from the Fed until March or April. Until then the best thing to do is to remember to zoom out and take a long-term view to avoid getting rekt.

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