We explore the interplay between interest rates, inflation and the elusive "Real Rates" - how they influence the dollar's strength and bond yields and ultimately determine winners and losers across asset classes.

Rate cuts could be delayed, yields will grind higher, and the crypto party faces an uncertain future.

Will Bitcoin breach below $40k? Can Ethereum hold $2k? What's in store for Solana?

Today’s market update simplifies how macro forces can rain on crypto’s parade in the short term.

TLDR

• Rates are set to move higher, meaning the DXY and yields will go higher, resulting in risk assets struggling, particularly crypto.
•  If we are right and prices do come down, that'll be the time to really risk on and start deploying your USDT bag to buy up your favourites at a discount.
•  In a month or two, we'll reassess this thesis.

Disclaimer: Not financial or investment advice. You are responsible for any capital-related decisions you make, and only you are accountable for the results. “One Glance” by Cryptonary sometimes uses the RR trading tool to help you quickly understand our analysis. They are not signals, and they are not financial advice.

The move in Real Rates

Firstly, we’ll start with what Real Rates are. A Real Rate is the "Real Interest Rate". It is an Interest Rate that has been adjusted for inflation. 

To calculate a real interest rate, you subtract the inflation rate from the nominal interest rate. If the Interest rate is 5.5%, and Inflation is 3.0%, then the Real Rate is 2.5%. You're getting 2.5% on top of inflation. 

Now, the Bond market is what prices rates. It is determined by the Bond price and the Yield (rate) offered on it. 

The Fed will then usually go along with the rate that the Bond market is pricing. 

Since the QRA on November 1st, Yellen and the Treasury announced that they'd be issuing less Bonds than expected, which saw Bonds get a bid in the market, pushing the price up and Yields down - also causing a rise in risk assets (a risk on environment). 

As a result, mortgage and credit card rates offered to consumers/individuals also went down as Bond Yields went lower. 

In addition, Bonds will get a bid, and Yields will go lower if the markets expect the Fed to cut interest rates.

If inflation stays where it is, there’ll be a reduction in the real rate. Say the Interest Rate goes to 5.0% (reduced from 5.5%) and inflation remains at 3.0%; then the Real Rate will drop from 2.5% to 2.0% (5.0% - 3.0%). 

This would be bullish for the economy and, therefore, for markets as the Real Rate has become less restrictive. 

However, if the Interest Rate is held at 5.5% by the Fed and inflation falls from, say, 3.0% to 2.5%, then the reverse is true.

Real Rates would have increased as the difference between the Interest Rate (of 5.5%) and the inflation rate (now 2.5% rather than 3.0%) has increased.

Analysing comments from Powell and Kashkari

At the January Fed Meeting (last week on January 31st), Fed Chair Powell pushed back on potentially reducing Interest Rates in March, calling it "unlikely". 

Alongside this, Fed Member Kashkar suggested that with such strong economic data, the Fed can take time with regard to lowering rates. 

He also suggested that the Real Rate may not be as restrictive as what we (they/the Fed) first initially thought. 

So, what do they do here? Raise rates again? 

This would be chaos if so. But no, they will just remain higher for longer – i.e. keeping the Interest Rate at 5.5%. 

The real question will be if inflation rears up again.

This means the Real Rate is reduced and, therefore, becoming less restrictive; what would the Fed do here? 

This could really worry markets if we get this. 

But to conclude the above, the Fed will likely stay higher for longer and not just begin to cut Interest Rates in March. However, it is likely also not to cut them in May.

It's now likely the first rate cut will be in June or even July, assuming inflation doesn't rear up. If it does, the Fed and, therefore, the markets have a problem because this would mean the Real Rate wasn't restrictive enough and is actually becoming less restrictive as inflation rears up again. This would be a bad case/scenario for markets. 

And unfortunately, we think we're potentially heading there.

What is the effect of all these on risk assets?

Essentially, following Powell's dovish Fed meeting in December, the market priced in rate cuts and risk assets were off to the races. 

However, what happens now when the number of rate cuts needs to be priced back out?

Alongside this, the economic data is coming in strong. Not just not showing signs of a slowdown, but actually showing signs of potential economic reacceleration. This would mean that the Real Rate was potentially never restrictive enough, and the Fed will be caught between a rock and a hard place, potentially needing to raise rates. 

They’ll do everything they can to avoid this, and this is likely the worst-case scenario. We're hoping that the worst case doesn't happen. 

But we do know that the market will have to price out some of these rate cuts. 

Think about it. 

Why would the Fed cut rates into an economy that's accelerating again? 

If anything, they need to raise again, as a reaccelerating economy risks inflation rearing up. 

What the above means is that:

• Bond Yields go up; bearish for risk assets.
• DXY (Dollar Index) go up; bearish for risk assets.

Where does the market go from here?

As a result, we likely see risk assets struggle to continue higher despite the dominance in fiscal spending – which is now potentially the main driver of risk assets.

The S&P may be somewhat immune, particularly the Magnificent 7. However, it's unlikely that crypto will be immune.

Therefore, we expect prices to be subdued or trend lower over the coming month or two as the markets price out rate cuts and push the first rate cut into June or even July. 

Therefore, we remain patient. We keep stacking USDT, and we'll look to deploy it in the coming months when we see crypto trading lower.

And to wrap it all up, the next few months will likely lead us towards lower prices as follows:

• BTC sub $40k.
• ETH at the $2k mark.
• SOL between $65 and $84.