2021: The Year for Turbulence Trading

KEY TAKEAWAYS 

  • Rising U.S. treasury yields triggered by the Federal Reserve’s discussion to taper purchases have incited a wave of panic in the crypto markets
  • The perils of short-term correction might be exaggerated, but market participants should expect higher volatility, which may materialize into better returns 
  • Despite talks of tapering purchases, concrete policy changes or even rate hike speculations are still premature; any correction overdone could be an opportunity for bottom-fishing 
  • BTC price has briefly bounced back since the re-opening of GBTC’s subscription program 

The price of Bitcoin had been on a parabolic rise for the first two weeks of 2021, despite the temporary void left by institutional players. Grayscale halted its subscription program mid-December 2020, only to re-open on Jan. 14 this year; so too did MicroStrategy put a pause on its crypto acquisition after completing its corporate balance sheet allocation* to bitcoins. 

*Any further allocation by MicroStrategy, a publicly-listed company, could change Bitcoin’s role from an asset allocation strategy to an investment vehicle.  

The price of Bitcoin continued to muscle through thanks, in large part, to retail FOMO. Even gold’s suffering failed to weigh on crypto investors’ sentiment. Riding on heightened market euphoria, crypto and stock market participants seemed to have collectively overlooked the crucial factor that led to gold’s largest price decline in two months: a factor hidden beneath the Federal Reserve’s discussion of a possible tapering of asset purchases. 

The Taper Talk

The Federal Open Markets Committee (FOMC) released minutes last week detailing a potential change in the direction of asset purchases, but remained vague about conditions that precede that change. Conditions include the Committee’s maximum employment and goals for price stability. Several participants noted that a gradual tapering of purchases will ensue once the “substantial further progress” threshold is reached. What the Fed hopes to avoid is another “taper tantrum” after curtailing the large-scale purchase program in 2013-2014. 

It is the first time the Fed is seen discussing the possibility of tapering since the March 2020 liquidity crunch. Under current circumstances, tapering purchases would entail reducing monthly treasuries on various types of maturities — approximately $80 billion — at an indefinite point in the future. The imminent reduction may evoke some bitter memories of gold slumping listlessly during the “taper tantrum” of 2013. We could expect Bitcoin, which mirrors gold in its characteristics typical of a scarce good, to react similarly once the expanding balance starts to show signs of slowing down. 

Meanwhile, traditional financial markets seem wary of the prospect of higher inflation, especially after Georgia runoffs flipped the Senate. A blue wave would undoubtedly become the harbinger of larger stimulus packages. This could translate into higher treasury auctions, leading to higher nominal yields, even though inflation may not ramp up immediately. The U.S. 10-year treasury yield jumped to 1.15% on Jan. 12, shattering the key psychological level of 1%. Even though the effect of the discussion on “tapering” has not massively cascaded into the crypto space, it is still worth keeping a keen eye on the potential risks that rising nominal yields could bring to risk assets.  

Of course, the discussion on “tapering purchases” does not guarantee an immediate shift in monetary policies. According to Richard Clarida, vice-chair of the Federal Reserve, the majority of FOMC officials agree on the projection that by the end of 2023, unemployment rate will fall below 4% and the Personal Consumption Expenditures (PCE) inflation will return to 2%. The projection, though still highly speculative, penciled in a tentative timeline for a rate hike, and the tapering under discussion may well happen before that. However, the market has exhibited signs of front-running the Fed, which implies that the first rate hike could come as early as November 2021. 

A 20% plunge in Bitcoin price is just the kind of response one could expect from concerns in rising yields — a concern that triggered massive panic dumping among less-seasoned market participants. Theoretically, market front-run could present better opportunities for short-term traders. This round of front-run, however, is likely to be fleeting as the Fed has promised to inform markets at least four months before any rate adjustments.  

Other evidence suggests that the crypto markets, though widely believed to be decoupled, is still intricately linked to treasury yields. Bitcoin climbed to an intraday peak of $40,100 after Powell clarified that “now is not the time” to be discussing tapering and reiterated that there will be plenty of notice before that happens. 

GBTC’s reopening of primary market subscriptions on Jan. 12 also provided further support to Bitcoin’s price rebound, as BTC is a high-yield asset with an annualized yield far exceeding 20% (current premium at 15.6%). The demand for BTC from GBTC’s premium arbitrage activities outweighed the effect of rising nominal yields. Meanwhile, the expected 1.9-trillion-dollar stimulus package breathed some life into the depreciating dollar. That bounce is expected to be short-lived. 

Volatility may not be for everyone. For short-term traders who thrive on market fluctuations, 2021 might just be the year for turbulence trading.