2023 will be hard for crypto traders judging by macro data

Key points: 

• The crypto market continues to face the same issues, with headwinds from Fed rate hikes limiting significant upside. Worst of all, this regime could last much longer than market participants expect.
• Minneapolis Fed President Neil Kashkari expects terminal interest rates to rise to 5.4% by June 2023 -- rates currently range from 4.25% to 4.50%.
• During the dot-com bubble, the Federal Reserve stopped raising interest rates in May 2000, but the Nasdaq slumped for the next two years. Therefore, we can expect the cryptocurrency market to at least continue to fall until the Fed reverses course.
• In November 2022, the U.S. dollar’s ​​M2 money supply has turned negative for the first time in 28 years.  It is an indicator of a possible recession, usually "before a slowdown in money supply growth".
• Most investors expect the cryptocurrency market to remain in a downtrend, awaiting confirmation of the Fed’s shift or quantitative easing.

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There is no doubt that 2022 is one of the worst years for bitcoin buyers, mainly due to the 65% price drop of the asset. While there are some clear reasons for the decline, such as the LUNA-UST debacle in May and the FTX implosion in November, the main reason is the Federal Reserve’s policy of rate cuts and hikes.

The price of Bitcoin has fallen from a 50% peak to a pre-LUNA-UST crash low of $33,100 due to the Fed’s rate hike. The first major drop in bitcoin's price came amid growing market uncertainty surrounding rumors of a possible rate hike in November 2021. As early as January 2022, cracks appeared in the stock market due to mounting pressure on the upcoming taper, which also negatively affected cryptocurrency prices.

BTC/USD 1D chart. Source - TradingView

Fast-forward a year, and the crypto market continues to face the same issues, with headwinds from Fed rate hikes limiting significant upside. Worst of all, this regime could last much longer than market participants expect.

Clues from the dot-com bubble of the 1990s

The dot-com bubble of 1999-2000 may inform investors about the current crypto winter and continue to paint a bleak picture for 2023.

The tech-heavy Nasdaq Composite surged to astonishing levels in the early 2000s, and when the Fed started raising rates in 1999 and 2000, the bubble burst. As credit became more expensive, the amount of easy money in the market decreased, sending the Nasdaq down 77% from its peak.

Nasdaq composite index chart. Source - Macrotrends

The crypto market is currently facing the same situation.

Federal Reserve Chairman Jerome Powell is determined to tame inflation, which means higher interest rates for a while. Minneapolis Fed President Neil Kashkari wrote in a recent blog post that he expects terminal interest rates to rise to 5.4% by June 2023 -- rates currently range from 4.25% to 4.50%.

Specifically, during the dot-com bubble, the Federal Reserve stopped raising interest rates in May 2000, but the Nasdaq slumped for the next two years. Therefore, we can expect the cryptocurrency market to at least continue to fall until the Fed reverses course. If the U.S. economy falls into a 2001-style recession, the current bear market could extend.

Growing signs of recession

In November 2022, the U.S. dollar’s ​​M2 money supply has turned negative for the first time in 28 years, according to a report by Mises Institute analyst Ryan McMaken. It is an indicator of a possible recession, usually "before a slowdown in money supply growth".

While acknowledging that negative monetary growth indicators can turn out to be false signals, McMaken added that it is "generally a warning sign for economic growth and employment. It is another indicator that the so-called soft landing promised by the Fed may never materialize."

Potential recession indicator using M2 money supply of USD. Source - Mises Institute

The latest report from the Institute for Supply Management also showed that U.S. economic activity contracted for a second straight month in December. The Purchasing Managers' Index (PMI) for December came in at 48.3%, with a reading below 50% signaling a decline. This suggests that demand for manufactured goods is falling, possibly due to rising interest rates.

U.S. recessions since 1857 have lasted an average of 17 months, while the six recessions since 1980 have lasted less than 10 months. Technically, this recession begins in August 2022, when two consecutive quarters of negative GDP growth occur. Historical averages suggest the current recession could last until June 2023 to January 2024.

Can profitable conditions be formed before 2024?

The crypto market needs areas of easy money to build a sustained bull market. However, based on the Fed's current plans, those conditions look remote.

Only a black swan event that forces the U.S. government to resort to quantitative easing of low-interest rates and economic stimulus, as it did during the COVID-19 pandemic, can spark another bull market.

According to independent market analyst Ben Lilly, a bubble may be forming in the consumer credit space, which has grown exponentially to nearly $1 trillion over the past decade.

The surge over the past two years has been particularly pronounced since the U.S. government halted stimulus checks. Lilly concluded that the industry could collapse if many borrowers default on their loans due to heightened economic stress. He also noted that "government stimulus will be needed to address this."

The timing of a bubble burst is one of the most difficult things to predict. It could coincide with the end of the recession sometime in late 2023 or 2024. Nonetheless, most investors expect the cryptocurrency market to remain in a downtrend, awaiting confirmation of the Fed’s shift or quantitative easing.

Year-to-date, the total cryptocurrency market capitalization has fallen by 75% from its $3 trillion peak. The 2017 peak of around $750 billion is a key level of support and resistance for the market. If that level is breached, the market value of the entire industry could fall below $500 billion.

Total crypto market cap chart. Source - TradingView

While a temporary bear market rally is likely, macroeconomic pressures could dampen any positive moves.