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Paribus

10/05/2023

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Beyond the Pause

Central banks globally are applying the brakes on interest rate hikes, igniting optimism among some quarters that perhaps the bear market’s end is in sight.

Beyond the Pause

Central banks globally are applying the brakes on interest rate hikes, igniting optimism among some quarters that perhaps the bear market’s end is in sight. Yet, a cursory glance at historical patterns suggests we might endure further pain before witnessing a market resurgence.

Although no two cycles are identical, certain resemblances are undeniable. As the famed American author Mark Twain aptly put it, “History doesn’t repeat itself, but it often rhymes.”

Despite emotional appeals for a new bull market in cryptocurrency, it remains intricately linked to other volatile assets, including tech equities. This association stems primarily from the investor profile: those who dabble in tech stocks are frequently the same individuals venturing into crypto.

As this market has a higher risk-reward profile, many investors will sell their tokens before their tech stocks when conditions are challenging. As such, the likelihood of crypto entering a bull run while traditional stocks remain bearish seems implausible.

The inflection point in market cycles invariably centers around liquidity, typically influenced by central bank interest rate adjustments. A more relaxed monetary policy boosts the influx of capital into markets, potentially initiating the bull phase.

It’s essential, however, to note that there is a big difference between pausing interest rate hikes and pivoting to interest rate cuts. The effect on the market is also quite different in both circumstances.

When central banks pause their interest rate hikes, this is to give them a chance to see whether the effect they intend is happening. It’s analogous to a driver cruising at 70 mph and merely taking their foot off the gas instead of braking.

The underlying sentiment remains geared towards implementing a restrictive policy to curtail inflation. These pauses do not indicate a complete cessation of rate hikes; they are merely breathers, often peppered with sporadic increases.

Market reactions to these pauses largely depend on whether they’re anticipated. They are usually clearly signaled ahead of time and often cause a slight increase in stock and crypto values, which is relatively short-lived. As with all things in the markets, surprise decisions cause a more profound effect.

Conversely, pivots are when the central bank changes its policy from tightening to loosening or vice versa. These changes have a much more significant effect on the markets due to the reasons for the pivot.

In the current restrictive climate, a switch to a more lenient stance typically indicates something in the market has broken. The US and Europe came close to this a few months ago when there was a spate of bank collapses.

The US opted for an ongoing bailout to avoid pivoting when inflation was still high. This meant that banks could access funding for collateral they held rather than having to sell bonds at a loss. This enabled many insolvent banks to continue trading and stabilize the financial system.

When a significant part of the market breaks, central banks reverse their policies and try to stem the damage. This situation is accompanied by a drastic drop in value across most markets. In time, the loosening of monetary policy causes markets to recover and prices to increase. As with all central bank interventions, the effect takes time to work its way through to the markets.

While banks are starting to pause their interest rate hikes, the pivot and its initial painful impact have yet to occur. This will likely happen sometime in the first half of 2024, and only after then will we see the first real glimmers of the next bull cycle.

In the meantime, there will be lots of short-term volatility with occasional breakouts and crashes. In the world of crypto, the rollercoaster ride of hope and despair is still far from over.

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