The bullish momentum from last week hit a wall on Thursday, 10 February, with the US CPI print coming out at 7.5% year-on-year and 0.6% month-on-month.
The stunningly high inflation print followed by the call for an extraordinary Fed meeting today (Monday) has led to talk about a possible inter-meeting hike by the Fed.
Naturally, asset prices have come under pressure. BTC traded below 42,000 and ETH below 2,850 after trading at highs for the week of 45,855 and 3,285 respectively.
While the market has been fixated on rate hikes, our primary concern has actually been Quantitative Tightening (QT), which is the shrinking of the Fed balance sheet. More specifically, we want to know how QT will be carried out.
The addendum note of the January Fed meeting “called for primarily reducing the bond portfolio passively by allowing securities to mature without replacing them”.
We think this suggested passive reduction (i.e. allowing assets to expire instead of selling) will be bullish for the market.
However, an active reduction (ie selling down the portfolio) would pose the real downside risk. And this is what we will be looking out for in this week’s FOMC minutes (17 February).
Equity vols have started to reflect this tail risk, with the VIX index rallying a massive 10 points, from 20 to 30 since the CPI print (Chart 1).
In stark contrast, crypto vols have hardly moved. BTC implieds remain stuck in the low 60s (Chart 2), in line with realised vol levels.
Which vol market is reflecting the risk accurately?
Our approach to this uncertainty is to remain long on the wings (far strike options) across the board while the rest of the book remains relatively neutral:
– Long ETH and Altcoin gamma (short-tenor options) against short BTC gamma.
– Long Altcoin vega (longer-tenor options) against short BTC and ETH vega.
So if the VIX is right and we do see some extreme spot moves, the book would have some protection from the long wings. Otherwise, we are keeping overall positions nimble and tactical until we form a stronger view.
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