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Bitcoin (BTC) is trading higher a day after U.S. Federal Reserve Chair Jerome Powell signaled he's prepared to raise interest rates more aggressively.
The leading cryptocurrency by market value changed hands near $42,700 at press time, a gain of about 4% on the day. A drop to $41,000 after Powell's comments was short-lived, and the prices rose to $43,350 early today. Futures tied to the S&P 500 are pointing to a 0.32% gain. The index was little changed on Monday.
"We will take the necessary steps to ensure a return to price stability," Powell said in a speech to the National Association of Business Economics on Monday. "In particular, if we conclude that it is appropriate to move more aggressively by raising the federal funds rate by more than a quarter-point at a meeting, or meetings, we will do so."
Powell put a 50 basis point increase on the table for the coming months, having raised by 25 basis points last week, and signaled 175 basis points of increases for the entire year.
Risk assets' resilience may stem from investors' tendency to be forward-looking and the fact that Federal Reserve money tightening is already baked in. Let's take a look at each factor in detail.
1) Fed tightening is priced in
Concerns over Fed tightening first gripped markets in early November. Since then, rates traders have gone from pricing in three hikes for this year to seven, 25 basis-point increases.
Before Russia invaded Ukraine, markets foresaw the Fed raising rates by 50 basis points in March. Now, traders are factoring in a 50 basis point hike in May. Bitcoin has dropped 38% since mid-November.
In other words, Powell's hint of aggressive rate hikes is hardly surprising. If anything, last week's hawkish Fed meeting and Powell's comments on Monday confirmed investor expectations and appear to have removed a significant amount of uncertainty from the market.
"Investors hate uncertainty more than they hate bad outcomes. And that's exactly where markets stand today," Jeff Dorman, CIO at digital asset management firm Arca, said in a blog post published Monday.
"The 'storm before the calm' had been brewing, and it looks like the storm has finally passed. Since markets are forward-looking and have long memories, investors had already priced in a 3-year tightening cycle before it even started. Looking beyond that is a world with much less unknown. That’s a good thing." Dorman wrote.
2) Recession concerns: a blessing in disguise
Forward-looking markets could be focusing on a recession and the prospect of the Fed returning to expansionary monetary policy to support the economy. According to the Fed Funds futures, interest-rate derivatives traders are pricing a rate cut as early as 2023.
The U.S. Treasury yield curve, represented by the spread between 10- and two-year bond yields, is just 17 basis points short of inversion, a recession indicator. Inversion occurs when the two-year yield rises above the 10-year yield.
"The inversion of the curve signals to investors that the Fed may compromise in the future, so it's a good sign in part," Griffin Ardern, a volatility trader from crypto-asset management company Blofin, said in a Telegram chat.
"Once the economy is in trouble, the Fed can only turn back to the road of quantitative easing. Based on current macro data, the current economic situation can support the Fed's hawkish policy, but the maximum period will not exceed two years," Ardern said.
The best time to buy the dip in risk assets is when the Treasury curve inverts to the maximum, according to Ardern.
3) Pre-options expiry bump
Bitcoin's tendency to gravitate toward the so-called "max pain point" – the strike price at which the most open options contracts expire worthlessly – ahead of the quarterly options expiry could be helping the cryptocurrency hold ground in the wake of Powell's comments.
"When the quarterly delivery of derivatives is approaching, in the case of large transaction size, the actual price will tend to come to the max pain point and be firmly anchored," Ardern noted. "A similar situation happened once on Dec. 31 last year."
Option contracts worth $3.56 billion are set to expire this Friday, data tracked by Skew show, and the max pain is $41,000, according to data sourced from Deribit, the world's largest crypto options exchange by trading volumes and open positions.
According to theory, the max pain point acts as a magnet for spot prices as expiration approaches. That's because option sellers, mostly institutions, sometimes try to push prices closer to the max pain point to inflict maximum loss on options buyers.
Since early 2021, bitcoin has seen increased volatility ahead of quarterly option expiries, with prices pulling back or bouncing toward the max pain point in the lead up to the settlement, only to resume the prior trend after expiry.