Darius Dell is the founder and CEO of 42 Macro, an investment research firm that aims to disrupt the financial services industry by democratizing overall risk management processes at the enterprise level.
Short term (less than 1 month): Our market signals process indicates a continuing challenging environment for risk assets. While the negative surprise in the US CPI data for April provided some delay, at 42 macro we don’t think the highly anticipated negative rate of change will do much apart from stimulating a permanent bottom in either stocks or bonds given our analysis From the inflation momentum in the second round and the latest future guidance from the Federal Reserve and the European Central Bank.
Medium term (three to six months): We continue to see downside risks to around $3,200 – $3,400 for a permanent bottom in the S&P 500 – which is likely to catalyze another 30-50% drop in bitcoin once the assets cross-correlation risks kick in. While this range could prove to be 200-300 pips too low once the fed sell option is taken into account, we believe it is important for every investor to understand the risks we still see on an up-front basis.
The base case scenario expects the US economy to return to inflation in April 2022 and May after a brief period of deflation before settling into persistent deflation by June. Inflation and deflation are two components of 42 “GRID Systems” macros that feature high volatility and variability across asset classes. Given this elevated portfolio risk requirement, it is likely that we are still in the middle rounds of bearish market(s) in the high-risk beta assets that we have been anticipating since the fall.
Since the Fed is unlikely to receive any signals from the labor market or inflation statistics to halt monetary tightening for at least another quarter (maybe two or three), it is likely that financial conditions will have to tighten considerably to force a dovish policy. While the growth dynamics in the United States and the world do not yet support such an adverse outcome, we believe that the simultaneous deterioration in the liquidity cycle, growth cycle and earnings cycle will continue to sustain a prolonged and systemic collapse in risk appetite.
Balance the risks surrounding the results of our model. In terms of what we believe to be a low-probability bullish case, risk inflation is peaking and decelerating faster over the next 2-3 months than we economists and the Federal Reserve expect, leading to a sharp repricing of the projected trajectory of the federal funds rate in money markets. Any sharp slowdown in inflation would also inflate real incomes and delay a more meaningful slowdown in growth by continuing declining growth as well as inflation (“Goldilocks”) in the United States and across large parts of the global economy. Goldilocks is a very bullish Bitcoin system, with an expected annual return north of 400%.
In terms of what we believe is a low-probability case, the deterioration on the geopolitical front amid increasing supply chain disruptions caused by China’s “zero COVID” policy may maintain the persistent inflation drive for another two or three months. This leads Fed officials to take additional action (in terms of market pricing) to tighten financial conditions in the tusks of the sharp slowdown in growth that our models continued throughout 2H22E. The resulting contraction is likely to be deeper and longer lasting, resulting in persistent jump conditions in recession probability models. Deep deflation – as evidenced by the growth delta (sigma) is very bad for bitcoin. This system features a negative 64% annualized expected return for the digital asset.
This is a guest post by Darius Dell. The opinions expressed are their own and do not necessarily reflect the opinions of BTC Inc. or Bitcoin Magazine.