Looking Ahead to 2023
With the new year upon us, what are the major levels we need to be watching, and what events may influence which direction we head next? In volume 23, we discuss this and more!
Welcome back Cignals family, hopefully, you’re enjoying the last hours of 2022 in style! Words can’t express my gratitude to all of you who have made our first months of service a truly amazing experience. It’s humbling to see how many users we’ve acquired in under a year, along with all the kind words and messages of support. As we approach our one-year soft-launch anniversary at the end of February, keep an eye out for major upgrade announcements that will be coming shortly after. We started with a simple objective, make Cignals the easiest order flow tool to utilize for profitability, regardless of skill level, bar none. We take pride in focusing on the features that matter most to your bottom line, keeping the platform sleek, stable, and running lightning fast. We know you’ll really appreciate what we have in store going forward to make trading multiple markets a breeze!
What a whirlwind 2022 has been in hindsight. We started out with the United States federal funds rate hovering around zero to 25 BPS. Before year’s end, the FOMC conducted multiple 75 BPS rate hikes which brought the target range to 425-450 BPS in mere months. As if raising rates in a straight line wasn’t enough to keep the price of Bitcoin on its heels, we witnessed the spectacular failures of Anchor, Terra, 3AC, Celsius, BlockFi, and of course, FTX. If you’ve been reading our analysis since last year, you knew that these rate hikes were coming, when almost nobody was expecting them to happen. Bitcoin has held up remarkably well in the face of what surely would have taken it deep down into the abyss a few years prior. Over the past twelve months, the industry has experienced one of the greatest stress tests it may ever face. Not since the Mt Gox collapse in 2014 has the resolve of Bitcoiners been tested so thoroughly.
While the bottom has not been formed just yet for Bitcoin in all likelihood, I do believe we are very close. The chance of a 2020-style liquidity crunch occurring sometime in mid-2023 after the first two FOMC meetings in February and March remains one of my main concerns. We will most likely get another step down from December’s 50 BPS move to a couple of 25 BPS hikes at both meetings bringing us to an EFFR of ~500 BPS (5% Fed Funds Rate), which is starting to look like the terminal rate. Simply put, this is where Jerome Powell will stop the hiking cycle and let the effects work through the economy. You may not agree, but there are numerous signs of a potential liquidity crunch looming, although we’ve held up relatively well during the continuous onslaught from both the Federal Reserve and the numerous ponzi scam implosions in the cryptocurrency space.
During the 2022 Fed tightening cycle, smaller banks have been utilizing the Federal Reserve’s discount window more frequently, which is never a positive development, as it indicates that these institutions are feeling the pressure on their balance sheets and have no other means to obtain emergency operational liquidity, which is illustrated in figure 1 above. Making matters worse, the Fed received a record $2.55T (yes, trillion) in reverse repo usage as of yesterday. Banks would rather drain their free cash and park it at the Federal Reserve than put it to work in the economy, which is quite telling, as this is how certain markets begin to seize up. Figure 2 below sheds light on how the Federal Reserve’s foray to combat inflation, has impacted banks (and other financial institutions) thought processes on risk and markets in general. You can clearly see a massive uptick in RRP usage this year as the Fed began to tighten in a straight line and collapse markets in the process.
The cherry on top is the 3Q22 FDIC problem bank and toxic asset list which shows a massive uptick from the mean. This is likely due to bad loans being made at high-interest rates resulting in defaults, among other things. If you look back, you can see this was the case in 2007-2008 as the Global Financial Crisis got underway and ultimately lead to the TARP and endless rounds of Quantitative Easing. If history is any indicator, a lot of this bad debt has likely been collateralized and distributed among a large number of banks and investment firms reaching for yield. Again, this would be very similar to what happened in the CDO market back in 2007-2008, which lead to numerous bank (and investment bank) failures during this period. We discuss the parallels between 2007 and today extensively in the Alpha channel on Discord, available to advanced-tier subscribers.
Figure 4 below shows us a monthly cluster and some areas of interest on the downside. While we have seen a modest uptick in the long/short ratio, and slight stabilization of open interest, there is still some imbalance left around the $15k handle that has provided support recently. This imbalance will likely be cleared before any move meaningfully higher occurs, especially given that Bitcoin has continued to fail at the $17k handle repeatedly over the last few weeks. Clearing this imbalance could open up additional downside, though, at the present time, there are large buy limits front running it slightly. As we know, the order book can change very quickly when price approaches resting limits, and if they fail to provide a meaningful bounce, there’s a chance that these limits get canceled/replaced toward the nPOC at $11k which would be an area of tremendous retail and institutional buying interest. Gun to my head, I don’t think in any scenario a liquidity crunch gets worse than the $9k nPOC, as this would represent an extreme discount relative to mining costs. There would likely be a massive panic bid if this did end up happening, similar to how Bitcoin reacted around the $3k handle during the 2020 flash crash.
We’ve also discussed in the Alpha channel how pivotal the $17k level truly is in sparking the next leg higher for Bitcoin. The longer we continue to close under $17k, the more likely a retest of the $15k imbalance becomes. On the flip side of this equation, if we did get over $17k and close it, this would open the door back up to the local highs of $18.5k and give us a shot of getting through the 3D LVN cluster, shown in figure 5 below, giving us a path towards the pre-FTX highs of $20.5k/$21k. There could be some initial resistance before reaching $20.5k/$21k due to the HVN cluster in the mid $19k area. Prior to the FTX fiasco, Bitcoin was in the midst of reclaiming the $22k handle, gearing up for another chance at rotating toward $24k/$25k which piqued the interest of both buyers and sellers on multiple occasions. Given that the dollar has likely topped, it’s extremely probable Bitcoin would have gotten another opportunity to test these areas again if FTX did not implode. Don’t discount this type of relief rally if we did manage to close over $17k, and take out the $18.5k local highs, as it would catch a large number of participants offside and likely cause a massive squeeze.
Final prediction for 2022 - Bottom likely forms around $13k/$14k during a liquidity crunch with the potential for a washout toward $11k nPOC. I think the rebound will be swifter than most imagine and could take us back toward $25k fast. Given that we’ve failed in the $25k area on the previous two attempts to retake the level, it really comes down to how reactive sellers are if we get back toward $25k this time. Remember, there’s a chance that we close $17k and start rotating higher without clearing the imbalance at $15k initially, so keep all of this in mind. Have a very happy and prosperous New Year! We look forward to continuing to serve all of our users and customers for years to come!
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***Any views expressed in the above are the personal views of the author and should not form the basis for making investment decisions, nor be construed as a recommendation or advice to engage in investment transactions.***
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