Arthur Hayes's "Signposts" Summary
The former head of the cryptocurrency exchange BitMEX, Arthur Hayes, has published a new essay titled "Signposts." The author examines the decisions of the Federal Reserve System (FRS) and the US Treasury, the adoption of which in March 2024 will have a short-term impact on financial markets. The essay also outlines the anticipated consequences for the cryptocurrency industry and describes a trading strategy for various possible scenarios.
Regulators, policymakers, and bankers are the signposts in global capital markets. We can analyze their decisions, assigning a certain probability to each outcome. And if market expectations diverge from our calculations, it means a trading opportunity has arisen.
I am confident in the inglorious end of the fiat system, but the path to it is still unknown, so it is important to remain vigilant and make thoughtful bets. By saying this, I mean that I have deployed enough capital (sold fiat and bought cryptocurrency) for this stage of the cycle but anticipate a significant market correction in March.
Below, I will outline my reasoning and key points, specifying the circumstances under which I plan to short the crypto market through bitcoin put options first, and then sell US Treasury bills, buying more cryptocurrency.
The Variables
There are three key questions that will arise in March and may become important indicators. Let's go through each of them.
Liquidity is injected into the system through a reduction in the RRP balance. When the balance approaches zero (in my estimation, around the level of ~$200 billion), an additional source of dollar liquidity will be needed.
The chart below reflects the RRP balance over the entire existence of the program. The horizontal white line is at the $200 billion mark, and I believe we will reach it in early March.
On March 12, bankrupt banks must find cash to redeem US Treasury bonds and other securities pledged as collateral in the Federal Reserve. Weeks before this, there will be a question of whether banks will be granted an extension of the "safety net."
The initial idea of the BTFP was for banks to provide the Federal Reserve with discounted Treasury bonds, receiving their nominal value in cash in return. When the program ends, banks must buy back the bonds, returning the dollars. But where will they get the funds for repayment if the cash had to be paid to depositors?
The Federal Reserve's March meeting is scheduled for the 20th. Currently, the market expects the regulator to announce a rate cut of at least 0.25%. This would be the first cut after a cycle of increases that began in March 2021.
If .. Then
Once the key questions are outlined, we need to assign probabilities to various scenarios and forecast the market's reaction.
If by the beginning of March, the RRP drops nearly to zero, financial markets will start to decline. Remember the spike in the yields of US Treasury bonds that occurred simultaneously with the stock market sell-off? The sole reason for this rally was the Treasury's quarterly report confirming the shift of borrowings to the short end of the yield curve.
With an increase in supply and higher yields on Treasury bills, money market funds (MMFs) will invest their cash placed in RRP into them. A reduction in the RRP balance, all else being equal, adds liquidity to the system. This is precisely why bond and equity markets worldwide saw growth.
Without new sources of dollar liquidity, bonds, stocks, and, I presume, cryptocurrencies will decline. However, we cannot be certain about the pace of the RRP decline, so I will monitor the indicator, adjusting my trading strategy accordingly.
March FOMC meeting
The BTFP expires on March 12, and the Fed's decision on interest rates will be made on March 20. There are six trading days between these dates. If my forecast is correct, during this period, several banks will become bankrupt, prompting the Federal Reserve to lower interest rates and resume the BTFP.
Technically, the US Treasury cannot lend money to banks (this is the Fed's prerogative), but if the Fed incurs losses by issuing loans against collateral with a lower value than the loan amount, the losses spill over to the Treasury and ultimately burden taxpayers.
Initially, Bitcoin and other financial markets will plummet rapidly, but they will recover before the Fed's meeting. This is because Bitcoin is the only neutral and solid currency not tied to any bank and traded globally. Bitcoin understands that printed money, no matter what it's called, is still printed money.
Alternative scenario
If my calculations are incorrect, the following scenarios may unfold:
- RRP will slowly decline, and this liquidity will continue to support financial markets by the end of the second quarter of 2024.
- The Treasury will announce an extension of the BTFP well before March 12.
In this case, the Fed's decision in March becomes irrelevant. Regardless of the direction in which the interest rate moves, the dollar liquidity injected into the market by the Fed and the Treasury will have a stimulating effect.
Let's return to my base scenario of RRP depletion by early March and the cessation of BTFP on the 12th, followed by a revival on the 20th in conjunction with a rate cut. My course of action for this scenario is outlined below.
Put option on Bitcoin
Only Bitcoin derivatives can provide a liquid macro-crypto hedge. I will use options that allow me to precisely know the maximum loss in the form of the paid premium. Additionally, with this instrument, there's no need to monitor liquidation levels, as is the case with futures or perpetual swaps.
I expect Bitcoin to face a correction of 20-30% from any level it reaches by early March. The indicators will be even higher if Bitcoin spot ETFs are launched in the U.S. by then, as expectations of hundreds of billions in fiat inflows could push quotes above $60,000 and lead to a subsequent correction of 30-40% due to the overflow of dollar liquidity. Therefore, I cannot buy Bitcoin until the March issues are resolved.
I will wait for the market peak at the end of February and then buy large put options expiring on June 28. To gain leverage, I will choose a strike from 20% to 25% off the amount, based on the price of the quarterly futures contract for June.
Many traders, especially option traders, struggle to find an exit point. In the case of options, you can correctly predict market movements but still lose money if you hold the position for too long.
If my predictions are correct, the market will start to meaningfully correct around March 12. Between the 12th and the 20th, I need to identify the bottom and exit the position in hopes of making a profit. However, if, despite accurate calculations, Bitcoin holds or grows, an immediate closure will be necessary.
By the end of March, we will return to normal developments. After the end of this short-term turmoil, the cryptocurrency may grow again amid speculation about the upcoming halving, and I will resume selling U.S. Treasury bills, shifting capital into Bitcoin and other cryptocurrencies.
Ultimately, I could be wrong, but if I am right, based on mathematical expectations, my profit will be much greater than that of most market participants.
Thanks: @global_investment_io/ @pillardev
My Debank: https://debank.com/profile/0x50662aede1e73a1f6ffc6b3bbb1ea5c4d8083ed5