Guests:
Zheng @ZnQ_ 626
LUCIDA Founder
2019 Bgain Digital Asset Trading League Season 1, Mixed Strategy Group Champion;
2020 TokenInsight Global Asset Quantitative Competition, Composite Strategy Group April Runner-up, May Champion, Season Champion;
2021 TokenInsight x KuCoin Global Asset Quantitative Competition, Composite Strategy Group Season Champion;
Vivienna @VV_watch
BuilderRocket Accelerator Research Partner
Entered the industry in 2017
Former research analyst at a blockchain investment fund under Foxconn
Former Huobi Defi researcher
Passionate about macroeconomic research
HighFreedom @highfree 2028
Entered the industry in 2016
Computer finance background
Currently a researcher at a brokerage firm
Proficient in timing based on USD liquidity analysis and macro analysis
Albert @assassinaden
Quantitative private equity fund manager
Former quantitative researcher in the foreign exchange market, specializing in statistical arbitrage and relative value strategies
Proficient in non-delta strategies and macro research
Emphasizes the ability to respond to cycles and navigate bull and bear markets
Reveals macro analysis framework
Zheng@LUCIDA:
With the development of the crypto industry, the correlation between market trends and macroeconomics is increasing, making macro analysis an essential part of market analysis. Today, I would like to talk to you about macro-related topics. Let’s start with the first question and share your framework and methodology for analyzing macroeconomics, as well as the underlying logic.
HighFreedom:
Crypto macro analysis consists of two parts: off-chain (non-crypto native) macro and on-chain macro (crypto native, with BTC on-chain data analysis as the core).
For off-chain macro, my analysis framework is like an inverted triangle, divided into three levels.
The first level is various data, such as employment, GDP, inflation, PCE, etc.
The second level is summarizing and categorizing the data. Although the data in the first level may seem disorganized, we can ultimately classify them into two categories: economic indicators and inflation indicators. The ultimate goal of the Federal Reserve, which formulates monetary policies (interest rate adjustments, quantitative easing/tightening, etc.), and the Treasury, which formulates fiscal policies (government spending, etc.), is to maximize employment and ensure price stability. In other words, the core goal of these two institutions is to ensure a healthy economy and controllable inflation.
The third level is the specific composition and future expectations of USD liquidity. The main components of USD liquidity include bank reserves, the Federal Reserve’s balance sheet, the Treasury’s balance, and overnight reverse repo account balances. We need to pay attention to the changes in these factors and the Treasury’s quarterly refunding announcements to judge the current and future USD liquidity situation.
Moreover, employment and inflation, these two core factors, are to some extent interrelated. For example, when the Federal Reserve decides whether to cut interest rates or stop quantitative tightening, it considers both employment and inflation data. Therefore, we need to analyze these data comprehensively to more accurately predict changes in USD liquidity. By analyzing quarterly refunding announcements and various economic data, we can better understand the operations of the Treasury and the Federal Reserve, and thus predict the future trends of USD liquidity.
These are the so-called off-chain factors, which mainly refer to non-crypto native content, such as the macroeconomic indicators mentioned above, policy changes, market sentiment, etc. Although these factors do not directly originate from the crypto market, their impact on the market is significant because they define the external environment of the market and investor expectations.
The second type is on-chain macro: on-chain macro refers to the data and analysis directly derived from the crypto market, with BTC on-chain data as the core. These data include changes in the holdings of long-term and short-term holders, profitability, etc. By analyzing these on-chain data, we can gain a deeper understanding of the internal dynamics of the market, including investor behavior and market trends.
These two sets of analytical methods have their own focuses. Off-chain factors provide us with a macro perspective, while on-chain factors allow us to understand the cycles and rhythms of the crypto market’s internal operations. When analyzing the crypto market, it is important to combine these two perspectives, as they together form a comprehensive macro analysis framework.
Albert:
I would like to add that in addition to the impact of the Federal Reserve and the Treasury’s policies, we should also pay attention to microeconomic factors such as bank deposits. For example, when faced with high interest rates, ordinary investors may choose to deposit funds in banks to earn interest, but this may also affect market liquidity. In the past, after the banking crises in the 80s and 90s, the growth rate of deposits significantly slowed down. Similarly, after the SVB incident in 2023, we saw a similar situation with a decrease in bank deposits while the stock market and other asset markets started to recover. In addition, international liquidity, such as the Japanese bank’s yen-dollar carry trade, also provides additional liquidity resources to the market.
During high-interest rate cycles, people tend to deposit funds in banks to earn interest. However, when banks face operational risks, investors may shift their funds to the stock market or other assets such as short-term government bonds. Currently, the yield on short-term US government bonds is close to 5%, which has attracted many investors. At the same time, investors may also choose to invest in stocks, derivatives, ETFs, etc., to seek higher returns.
In the event of a banking crisis, investors may reassess the safety of depositing funds in banks. They may choose to invest in the stock market or other assets to seek relatively safe returns. This situation occurred in the 90s and in 2019. In addition, the performance of money market funds can also serve as an indicator of liquidity. Starting in 2023, the growth rate of money market funds reached a new high in over 20 years, reflecting the market’s demand for liquidity.
Ideally, we should consider all possible factors that may affect the market, including the liquidity conditions in other countries. However, in practice, we may not be able to analyze all factors due to the difficulty involved. For example, the impact of the carry trade in Japan and Europe on the market is significant but difficult to quantify. We usually focus on the United States as the primary concern and consider the influence of other countries as secondary factors. Nevertheless, we cannot ignore the impact of the offshore USD market.
Vivienna:
On Twitter, I published an article discussing the impact of US liquidity on cryptocurrency prices. I mainly focus on domestic factors rather than the offshore USD market, as data from the latter is difficult to quantify. When analyzing Bitcoin prices, I classify the influencing factors into three categories:
The first category is observable indices, including the federal funds rate, government bond yields, the US dollar index, and gold prices, among others. These indices form the basis of market expectations, but their relationship with the prices of risk assets is not directly linear. For example, interest rate hikes usually lead to tightening market liquidity, which is unfavorable for the rise of risk assets, while rate cuts have the opposite effect. However, this impact is influenced by the complex interplay of monetary policy transmission mechanisms, economic and financial cycles, and market sentiment, and does not have an immediate effect on market liquidity at the moment when monetary policy is implemented.
The second category is liquidity indicators, such as the Federal Reserve’s balance sheet, reverse repo operations, and Treasury account balances. These indicators directly affect USD liquidity, thus influencing the prices of growth-oriented risk assets like Bitcoin. For example, expanding the Federal Reserve’s balance sheet, reducing reverse repo operations, or depleting the Treasury General Account (TGA) all increase market liquidity, benefiting risk assets.
The third category is sentiment indicators, including dot plots, statements from Federal Reserve officials, labor market data, inflation data, etc. These data have a short-term impact on market expectations and sentiment, affecting short-term trading cycles. However, it is worth noting that traders should focus on changes in expectations rather than the data itself.
How do macro factors affect the crypto market?
Zheng@LUCIDA:
So how do you apply your macro analysis framework to the crypto market? Or in other words, how do these frameworks guide your trading and help you make profits?
HighFreedom:
I think there are three ways to understand how to make profits:
The first is to make money from the overall market trend. This means buying and holding spot positions when the market trend is clear, without frequent trading, and maintaining patience.
The second is to make money from market volatility. This usually involves quantitative trading, taking advantage of market volatility to buy and sell, without focusing on the specific direction of the market.
The third is to make money from liquidity. During a bull market, you can invest your funds in the market and earn high interest by lending to traders in need.
Personally, I believe that macro factors mainly affect the crypto market through two aspects: liquidity and penetration rate. Liquidity determines the amount of funds in the market, while the penetration rate refers to the proportion of funds allocated to cryptocurrencies like Bitcoin.
In terms of operations, I tend to be fully invested in spot positions during a bull market, especially in mainstream currencies like Bitcoin. This is what I mentioned earlier as the first way: making money from the overall market trend.
At the same time, I will use a portion of my funds for leveraged long positions, but I avoid frequent long and short operations during a bull market. I believe the key is to identify market highs and lows, which requires a comprehensive consideration of various sources of information, such as miners’ costs, market sentiment, borrowing rates, funding rates, etc.
The market performance in the second half of 2021 shows that the highs of Bitcoin prices coincide with the highs of the Nasdaq index and USD liquidity.Sure, here’s the rewritten article with a creative re-expression while maintaining accuracy and fluency:
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In the context of temporal relationships, it suggests that when liquidity peaks, risk assets may need to prepare for exits. Therefore, I closely monitor liquidity indicators to gauge whether the market is nearing its peak or trough.
Additionally, I believe in information orthogonalization, which involves gathering diverse perspectives to form comprehensive market judgments. This approach helps us pinpoint market highs and lows more accurately, facilitating sound trading decisions and minimizing operational errors. I also adjust my risk management strategy based on market conditions to safeguard my investments during market fluctuations.
Vivienna added insights on Twitter, recommending the book “Principles of Professional Speculation” by Spolandi, which outlines two fundamental principles for market analysis and forecasting. Firstly, market trends result from fundamental economic forces influenced by political systems and policy actions. Secondly, the psychological state of market participants determines the manner and timing of price movements.
Macroeconomic analysis should focus on these aspects. Firstly, understanding the fundamentals of politics and economics such as economic indicators, production-consumption cycles, investment-savings behavior, and technological innovation paths is crucial. Secondly, forecasting the psychological states of market participants provides stronger guidance for trading decisions. Macro analysis often faces scrutiny because many overlook expected changes, overly focusing on economic and financial data. Successful trading requires not only analyzing current data but also anticipating changes in expectations and understanding market dynamics.
Soros famously noted that economic history is built on false narratives rather than truths. The path to substantial gains lies in analyzing erroneous trends, trading with the trend, and exiting before they unravel. This principle underscores the importance of distinguishing correct trends by understanding policies like high-interest-rate policies during economic recessions or attempts to stimulate the economy through monetary policy adjustments. Without comprehending these policy transmission mechanisms, predicting outcomes and exiting before issues arise is challenging.
Albert discussed how macro analysis frameworks impact the cryptocurrency market and our trading strategies. Since 2020, we’ve discussed the long-standing theory of the liquidity chain. Based on risk analysis, assets like commodities, forex, and stocks are ranked in a chain. Cash sits at the top with minimal risk, except for inflation. If even cash faces risks, it signals a potential global market reset.
The second layer of the liquidity chain comprises bonds, especially government bonds, seen as low-risk fixed-income assets. The third layer includes corporate bonds and stocks, offering relatively higher returns. Commodities form the fourth layer with higher volatility and risk. Cryptocurrencies occupy the last layer, characterized by the highest volatility and risk within the liquidity chain.
This theory explains the phenomenon Highfreedom mentioned, where peaks in Bitcoin prices follow peaks in the Nasdaq index and USD liquidity. Liquidity release initially impacts the forex market, followed by the bond market, then stocks, commodities, and finally, cryptocurrencies. Conversely, during liquidity tightening, the process reverses. The sequence of liquidity flows significantly influences the market.
As traders, we use this framework to guide our strategies. For instance, observing signs of liquidity tightening or release allows us to predict market reactions and adjust our trading strategies accordingly. We closely monitor interbank rates and bond futures as they reflect the market’s initial response to policy changes. We then analyze options markets, as option prices indicate future volatility expectations.
Our trading strategies primarily hinge on these macro expectations. During rate hike cycles, market sentiment tends towards bearish, prompting us to allocate towards put options during low volatility periods. Simultaneously, we adjust our option portfolios based on market sentiment and expectations to profit from volatility regressions.
Our strategy relies on volatility regressions, especially near-term volatility. Far-term volatility may remain elevated for extended periods without immediate regression. Therefore, we typically act as buyers in the far-term, using spread configurations to capture value differentials. Our portfolio strategy entails holding both near and far-term options to profit from their value differentials.
Regarding the position of Bitcoin among major asset classes, Zheng@LUCIDA posed a more straightforward question, indirectly touched upon earlier: the role of Bitcoin within traditional assets. I recall in 2019, especially in the first half, Bitcoin was widely viewed as a safe haven asset, with its price rising alongside gold amid geopolitical crises, increasing acceptance of this view in the market.
However, with the bull market cycles from 2020 to 2021 and the situation in 2022, the public gradually accepted Bitcoin as a riskier asset compared to traditional risk assets. I’m curious if everyone agrees with this positioning or if there are other descriptions of Bitcoin’s place among major assets.
HighFreedom affirmed this description as fairly accurate. He believes Bitcoin is undoubtedly a higher-risk asset in the short to medium term. However, he’s confident in Bitcoin’s potential to evolve into a safe haven asset in the long run. He believes several fundamental elements are necessary for an asset to qualify as a safe haven:
Firstly, it must have a large market size, allowing significant capital movement.
Secondly, its volatility must decrease. While Bitcoin historically has high volatility, it has significantly reduced, often matching or even falling below gold’s volatility.
Thirdly, rational and stable market participant behavior. As market participants transition from insiders to more traditional, rational financial institutions, market stability may increase.
When these conditions are met, Bitcoin could mature into a safe haven asset with a large market size and lower volatility, akin to gold. During such times, even major events would have minimal impact on its price.
Vivienna suggested Bitcoin is often dubbed digital gold, a comparison widely accepted. Bitcoin’s fixed supply resembles gold’s scarcity, and it serves as both a store of value and a means of payment, aligning closely with gold’s characteristics.
However, pricing gold remains complex. During heightened risk aversion, such as during wars, gold’s safe haven properties become pronounced. If basic market liquidity isn’t strained but geopolitical factors are significant, Bitcoin may follow gold’s price movements because safe-haven sentiment predominantly influences gold prices. Correspondingly, Bitcoin prices also respond to safe-haven sentiment.
Yet, if fundamental market liquidity is insufficient, such as during global or US economic recession cycles or expectations of recession, even heightened safe-haven sentiment may fail to stimulate trading volume. This explains why some geopolitical conflicts provoke significant reactions in other markets. In such scenarios, basic market liquidity determines the price bottom line, making Bitcoin closer to a risk asset.
Therefore, the correlation between gold and Bitcoin prices primarily depends on current market liquidity and perceptions of Bitcoin’s attributes. Most of the time, Bitcoin prices are highly correlated with US stocks. During economic contraction, investment contraction, and deleveraging processes, Bitcoin reacts first and accelerates more than other assets during economic recovery and re-leveraging. Gold holdings typically remain below 5% in global asset management companies due to the high uncertainty of gold prices. While gold has practical applications, it is largely influenced by speculation and emotions, lacking fundamental analysis. This makes it challenging to justify to LP (Limited Partners) why gold investments should be made, relying instead on predictions of future economic downturns or risks, which are highly subjective and difficult to convince.
Bitcoin faces similar challenges, struggling to persuade capital companies and LP to allocate funds to this asset. While gold is considered a safe haven asset, its ability to counter inflation mainly appears over the long term. Bitcoin may also be similar. Its position in the future may be very high, especially as Bitcoin mining difficulty increases. If more traditional financial management companies enter the Bitcoin investment field, Bitcoin’s investment ratio may converge towards gold.
Albert viewed gold and Bitcoin from a macro perspective, noting their multifaceted attributes as both risk and safe-haven assets. This phenomenon initially appears contradictory but has intrinsic logic.
Firstly, whether gold or Bitcoin, both serve as safe havens during crises. During wars or other tumultuous periods, asset transfers are restricted, and liquidity seeks secure havens. Investors tend to move funds to assets easily transacted across borders, such as gold and Bitcoin. This leads to substantial price increases for these assets during crises.
However, in stable marketCertainly! Here’s a creatively rephrased version of the article, maintaining the original semantics and accuracy:
During different periods, gold and Bitcoin exhibit distinct properties. Bitcoin, known for its high volatility, is primarily seen as a risky asset. Its price fluctuations often correlate with the stock market, partly due to the extensive use of leverage and the large number of market participants in the Bitcoin market, resulting in significant price swings.
In stable environments, investors tend to favor conservative portfolios to avoid substantial price fluctuations. Therefore, they may prefer allocating to traditional assets such as gold and other commodities. Gold, with its historical longevity and stable value, typically remains within 5% of investment portfolios.
Moreover, the prices of both gold and Bitcoin are influenced by market expectations. When liquidity is abundant, investors may seek higher-yielding assets, whereas during liquidity contractions, they may revert to traditional safe-haven assets.
Finally, the status of Bitcoin and gold as safe-haven assets also depends on market conditions and the macroeconomic cycle. Under specific circumstances, they may exhibit safe-haven characteristics, while in other situations, they may lean towards being perceived as risky assets.
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Macro Analysis Insights:
Zheng@LUCIDA: Let’s discuss macroeconomic analysis. What data sources do you typically rely on? Do you collect data yourself or use unconventional analytical tools? Any exclusive sources you can share?
HighFreedom: I’ve developed a dashboard on TradingView to continuously monitor macro liquidity trends. These tools integrate data similar to what’s available on official sites like the Federal Reserve and Treasury, but in a consolidated interface for ongoing monitoring. Additionally, I follow analysts on Twitter, particularly a Taiwanese blogger who aggregates intriguing data, such as lending rates across different exchanges. These insights reflect the trading trends between large and retail investors, which I find highly valuable but haven’t fully integrated into my tools yet.
I’m also searching for data on U.S. bonds, specifically daily net issuances of short and medium to long-term bonds (net issuances being the difference between newly issued bonds and bonds maturing on the same day). Understanding these figures is crucial for assessing current and future market liquidity. Currently, I manually download and process data from the U.S. Treasury website. Recommendations for better data sources would be greatly appreciated.
Albert: I’d like to add some macroeconomic data sources we monitor, particularly focusing on commodities. I utilize services like Spotgamma Menthor Q, providing comprehensive data on U.S. stocks, bond markets, and other commodity options, which are quite extensive.
For real-time data on U.S. stock markets, services like GR offer affordable pricing. For deeper insights, such as gold or interbank market data, industry-specific resources are often necessary.
For cryptocurrency markets, Amber Data Derivative is a recommended source, offering thorough options data, particularly advantageous for exchanges like CME. They provide real-time insights that are crucial for understanding market expectations at the institutional level, significantly influencing market dynamics.
Additionally, exchanges like Deribit, where 80% of trading volume comes from institutions, offer valuable insights into market sentiment at the institutional level. Exchanges such as Bitfinex serve as the interbank market for cryptocurrencies, with their short-term lending rates reflecting risk-free rates, essential for calculating risk premiums in the crypto market.
Regulated exchanges like Coinbase and their data on large-volume trades are also crucial, particularly dark pool trading data, which can impact market dynamics.
In conclusion, while abundant market data is available, trading decisions ultimately rely on our own risk management capabilities. Our goal is to minimize losses or break even in most cases, aiming for significant gains in select opportunities.
Review and Outlook for this Cycle:
Zheng@LUCIDA: Let’s address the final question regarding future market outlook.
I’ll start with my perspective: the market widely anticipates significant liquidity from the Federal Reserve in the latter half of this year or next year, combined with bullish factors like Bitcoin halving, leading many to predict a bull market similar to 2021. However, I’m cautiously pessimistic about this widespread optimism because historically, highly consistent market expectations often accompany substantial potential risks.
Especially regarding U.S. mutual funds and other institutional investors, while they are long-term holders, they adjust their investment decisions based on market conditions and avoid blindly chasing highs.
HighFreedom: My view aligns closely. The current market’s primary uptrend began in November last year, particularly evident after January’s ETF trading, causing significant volatility. The first quarter saw increased liquidity and penetration, primarily driven by retail participation, with institutions yet to make substantial entries. For example, 80% to 85% of funds flowing into ETFs are from retail investors. Liquidity declined slightly in the second quarter, with penetration rates leveling off. Looking ahead to the third and fourth quarters, I hope for stable liquidity and increased penetration due to further institutional participation.
I believe rate hikes or cuts won’t immediately change liquidity but will alter market expectations of future liquidity. My concern is whether we’ll see as loose fiscal and monetary policies as in 2021, which currently seems unlikely. Therefore, I’m cautious about overly optimistic market expectations in the future.
Short-term market changes may be minimal, with expectations of 4 to 5 rate cuts over the next 15 months providing steady expectations. However, significant liquidity releases will be gradual, unlikely to cause massive rapid changes unless a severe economic recession or crisis occurs.
If no severe economic downturn occurs, this rate cut is likely a so-called “asymmetric rate cut.” Previous rate hikes and cuts were symmetrical; for example, it took about a year to raise the federal benchmark rate from a low to a high point. Reversing this process from a high back to a low point would take a similar time. However, this rate cut might take an asymmetrical route, with a slow and gradual process.
Vivienna: My conclusion is relatively straightforward and similar to everyone’s views. From July/August to year-end, the market may face less optimistic liquidity conditions. Even with a rate cut, it might only happen once, providing positive expectations but not fundamentally changing the situation.
The current economy isn’t in recession, and the stock market may continue to rise. People’s lives don’t seem greatly affected; deposits and dividends still support household savings and promote consumption. However, persistent inflation could trigger expectations of a stagflationary trading cycle. If high rates continue into next year or require further hikes in some cases, and the Treasury doesn’t ease policy, it could lead to tighter liquidity next year. For liquidity-dependent markets like Bitcoin, this is certainly not good news.
Regarding the wish for substantial institutional investor participation, I think it’s more of an expectation than reality. In the current environment of poor base liquidity, limited understanding of cryptocurrency markets, and high volatility, institutional investors are unlikely to make large-scale allocations. This expectation may be overly idealized, and the reality may not meet our hopes.
Albert: Currently, short-term market expectations lean towards bearish, especially for Bitcoin. Although factors like options expirations may increase market volatility in July, the asset allocation cycle may drive price increases in the long term. However, for the market to rise, it may rely on two factors: significant institutional investor allocations and further improvements in investor sentiment. Yet, sentiment-driven increases may not be healthy, as high funding costs and volatility are challenging to sustain long term.
In my view, market uptrends will be gradual, as the gradual inclusion of market participants is a progressive process. The use of derivatives and leverage is unlikely to drive short-term market movements. In this scenario, market macro factors may only influence market maker hedging actions, rather than directly impacting prices. This could make the market appear more irregular, increasing the difficulty of executing strategies like CTA.
Overall, significant collapses or rapid uptrends are unlikely in the short term, but rather a slow and prolonged process. Liquidity won’t experience significant ups and downs unless a severe economic downturn occurs. Investors should remain cautious, focusing on institutional investor allocation trends and changes in market sentiment.
