Economic recession, FED squeezes liquidity & affects Stablecoins

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The traditional financial system is facing the problem of economic recession, the Fed continues to squeeze liquidity. How do they affect the Crypto market? Join Coin98 Insights to update the latest information on the traditional financial market.



Crypto in recent years has received more attention from major global financial institutions and institutions. This is good for the long-term development but will lead to a consequence that the macro-related factors out there will have some impact on this market.

Below is an analysis of events and topics related to the traditional economy that have had a great impact on the crypto market in the past time.

Overview of the traditional financial market

Take a look at the key financial metrics

Tight monetary policy by the Fed and other central banks globally amid rising inflation has put pressure on most financial markets and various asset classes.

Accordingly, the S&P 500 continued to experience continuous declines. By the end of May, the index had dropped ~16% since March.


“Buy the dip, sell the rally” (buy when the market plummets and sell immediately when there is a retracement), this is the current state of the US stock market over the past 2-3 months, showing cash flow unsustainable as well as negative views of investors.

Source: Bloomberg
In the bond market, although there has been a decline of 0.4% since the peak on May 9, but looking at the long-term trend, the yield of the 10-year US government bond is still in an uptrend.


The trend of selling bonds (due to the expectation that the FED will continue to raise interest rates sharply) is still happening.

Gold, an asset seen by investors as a hedge against political and economic instability, is also under selling pressure due to cash outflows from the market.


Besides, oil prices continued to increase, putting strong pressure on inflation, prompting the FED to continue raising interest rates.

Not out of trend, the crypto market also lost 2.7% of the total capitalization, continuing to sink in the red (data updated on May 21).



Hot issues of the week

In general, news and events from the CeFi market affecting crypto are not very positive, such as:

  • The Fed will continue to raise interest rates and shrink its balance sheet to cope with high inflation.
  • After the UST loss of peg , the issue of stablecoins became even hotter and was a topic of constant discussion among lawmakers.
  • The hostilities in Russia and Ukraine continue to escalate and show no signs of cooling down, which is a bad sign for the global economy.
  • In the bear market, a lot of negative news from the media is released that affects the emotions of investors (typically the headlines about the Coinbase event "potentially bankrupt" ).
However, our picture is not entirely gray:

  • The Spot Crypto ETF in Australia has officially been traded. If performed well, the fund will serve as a benchmark for other countries and fund management companies to expedite the further expansion of these products.
  • Robinhood is developing a non-custodial wallet product to compete with Metamask. With this move, Robinhood has confirmed the potential of crypto and will develop products directly linked to this market in the future.
[Coin98 Insights TV] The content of the article has been converted into a video titled "Economic recession, the Fed raises interest rates and the problem of Stablecoins (Week 21/2022)". You can watch it right here.


The Fed and the "soft landing" plan

Regarding the roadmap for raising interest rates, the FED still maintains its view on continuing to raise 0.5% in all upcoming meetings. The event that negatively affects the Market is at 0.75% ⇒ This will be a bad scenario set by Wall Street in a situation where macro indicators are difficult to control.

FED “Soft Landing” ensures the following factors:

  • No negative impact on the economy.
  • Guaranteed employment data.
  • Inflation curbs.

Important macro indicators affecting the decision of the Fed

1. Unemployment rate


The unemployment rate is still in a downtrend and remains stable, this is the motivation for the FED to maintain its roadmap and not consider the 0.75% figure because:

  • Rapidly rising interest rates will affect businesses because they have to bear interest rate pressure.
  • Contribute to increased operating costs.
  • Leads to an increase in unemployment.
In particular, in the context of the economy facing many difficulties, slow growth, and falling demand, the shocking increase in interest rates will have a negative impact on the job market.

2. Economic growth

Economic growth in the US as well as globally is predicted by the World Bank to be low in 2023.

Source: World Bank
Economic growth forecast in 2023 is even lower than 2022. Therefore, it is also difficult for the Fed to raise interest rates to contain inflation because it will simultaneously reduce the growth rate of the whole economy.

It is possible that the FED raised interest rates during this time, in addition to curbing inflation, it also has the purpose of saving "room" for further interest rate reductions in the following periods. When oil prices are stable, the economy is not disrupted by the epidemic, it is possible to increase interest rates to stimulate recovery.

3. Inflation

Thus, when analyzing two variables, unemployment rate and economic growth, we have not seen the possibility that 0.75% interest rate will be raised in the next meeting. However, there is still the inflation index factor.

Inflation continues to gallop (currently above 8%) will be the driving force for the FED to have a more "hawkish" view.

There are many types of goods that make up the CPI, but there are a few types of factors to pay attention to below:

  • Energy: 8.3%
  • Food: 13.36%
  • House price + Rent: 32.45%
Source: US Department of Labor

In which, energy and food are likely to remain high (due to their dependence on oil prices as well as Russia and Ukraine being the leading countries in wheat production).

According to CME Groups, oil prices in 2022 are likely to remain above the $100/barrel mark and will decline from 2023.


A variable that strongly affects oil prices is the "zero covid" policy of blocking the economy from China. In the event that this policy is gradually eased (many are expected in 3Q2022), it will lead to a sudden increase in demand, resulting in a sharp increase in oil prices.

At this point, it is almost certain that the US will release inflation data that may be higher than experts' forecasts, causing financial markets to panic in the short term (like the phenomenon we saw last May when the US announced inflation rate of 8.3%).

In terms of house prices and rents, it is likely to decrease because an increase in interest rates will partly curb the wave of speculation. The rent is also likely to cool down accordingly.

Rent tends to increase slowly in January 2022
In general, it is possible that inflation will be controlled and the economy will return to normal, but in the short term, it is unlikely to decrease immediately. Besides, there will be risks from the variables mentioned above. As a result, the market will move according to these risks.

What will the stock market look like?

In the context of increasing correlation between crypto and the stock market (specifically US stocks), Coin98 Insights will offer some perspectives in the near future.

In general, the Fed's interest rate hike combined with liquidity squeeze, accompanied by a slowdown in the economy, will be a negative thing for businesses. At that time, they will have to face the pressure of reduced profits, increased costs, and possibly even bankruptcy.

And the stock market and even the bond market will then be negatively affected.

The chart shows that the business's earnings are going down
When compared with the above economic scenario, it will not be until 2023 - 2024 that the market will be able to grow again because then the FED is likely to reduce interest rates, as well as the impact from oil prices and inflation will subdued.

About quantitative tightening

The most recent historical quantitative tightening took place from late 2017 to September 2019. The US stock market then continued its uptrend and then collapsed in mid-2018. It was not until June 2019 that the S&P 500 index returned to its old peak.


Thus, according to the latest historical data, the stock market will take 1-2 years to recover. But as analyzed in the article about the Fed's sharp increase in interest rates in May 2022 , the scale of the balance sheet contraction this time will be much larger than in the 2017 - 2019 period.

Therefore, it is likely that the stock market will take more than 2 years to break through the old top, and this will somewhat negatively affect crypto. However, it is likely that crypto will become more widespread and will gradually lose its correlation with the stock market.

Stablecoin issues

US Department of Finance speaks out

After the loss of UST peg (Terra's stablecoin) affected the entire crypto market, US Secretary of the Treasury Janet Yellen spoke out on the matter.

Source: Bloomberg
Accordingly, Ms. Yellen emphasized that the relevant legal frameworks must be developed quickly to prevent risks to the US financial system.

However, she mentioned that the current stablecoin market with about $160 billion in market capitalization is not enough to be considered a potential threat. However, this market is growing very fast.


The established legal system that controls the stablecoin market (especially centralized stablecoins) will help ensure the transparency and safety of these coins. Therefore, the FUD information about Tether, Circle or any other centralized stablecoin in the future will be gone.

Tether loses peg

After the Terra UST event, Tether USD ( USDT ) was also affected. The largest stablecoin in the crypto market currently has lost about 10 billion USD in capitalization.

USDT capitalization dropped from 83 billion USD to only about 73 billion USD
USDT also experienced a short period of strong price volatility from May 11-14.


Despite 10 billion USD withdrawal, USDT still holds the peg. This shows that Tether's treasury is still doing very well, ensuring enough backed assets for USDT.

So what assets are in Tether's current treasury? According to the latest report (updated to the end of March 31, 2022), Tether's asset structure is distributed as follows:

Source: Tether
With the amount of money and cash equivalents accounting for more than 85% of assets, it will help Tether withstand a large amount of redeem (about 70 billion USD).

This structure is much more solid than the data announced by the company in March 2021 (only about 76% is cash and cash equivalent).


However, we do see an increase in the percentage of Other Investments (from 1.64% to 6.02%), which puts the risk of continued Tether FUDs in the future.

Be careful when following the news

In the context of the bear market, the account as well as the psychology of investors has been under quite heavy pressure, the media coverage tends to amplify this even more.

For example, the event about Coinbase "bankruptcy" was headlined by newspapers, which is likely to mislead readers.

Details of the Coinbase incident have been analyzed in an article, which you can read here .

Besides, when prices go down, as usual, we see negative comments directly attacking Bitcoin and crypto.


Therefore, when investing, we always need to keep a cool head to make the most objective decisions possible. When following the news, it is necessary to understand the nature of the problem so as not to be emotionally affected by these media.

summary

In the context that the economy and monetary policy of central banks are not supportive, it is difficult for the financial market to grow well. Therefore, we need to prepare reasonable investment plans to avoid potential risks in a volatile season.

Hopefully this article has helped you update your overview of factors from the traditional market that have influenced crypto in the past week. If you have any questions or interesting questions, please comment below to share and discuss with the Coin98 Insights team.
 

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