Looking through the Eyes of an Economist 👀🔍

This issue is a detailed summary of our previous weekly analysis with Sani Hamid. I’ve also decided to make the full replay public for everyone to watch/listen. You may access it here.

This Week’s Top Headlines

i) FOMO dominates the market. Bitcoin climbs past $23,000 despite expectations of a retracement. It is currently testing $24,000.

ii) The Relative Strength Index (RSI), which tracks the relationship between buyers and sellers, jumped to the “extreme-overbought” region, a level not seen since January 2021.

iii) The dollar continues to weaken. It is now at 4.2388 against the ringgit, and has lost 9% in the past 2 months against other currencies due to a shift in investor favor towards emerging markets (China, Malaysia, etc).

iv) 98.4% of investors believe that the Fed will go with a 25 basis point hike during its upcoming meeting on Feb 1. The slower pace of rate increases has already been factored into the market. The question remains as to how high rates will peak this year before the Fed pauses/pivots.

Scroll down to read the details.

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Let’s talk about this rally from the eyes of an economist.

You may be growing a bit tired of me talking about how the crypto market has been green across the board in the past few weeks, but I’ll just hit you with some numbers:

• Bitcoin is up another 6% in the past week after a whopping 37% rally the weeks prior.

• The Relative Strength Index (RSI) has never been this overbought since January 2021, seriously suggesting that the market is extremely overheated.

• Meanwhile, the sentiment in the crypto market has returned to greed, indicating the FOMO from investors as they attempt to chase the bottom.

  

  Image: Alternative

Apart from the reasons I covered in my previous issue, Mr. Sani, an economist and certified financial planner, noted that the rally was supported by several factors, namely:

1. The improvement in the US equity market.
   
   All three major indices (S&P, Dow, Nasdaq) are up at least 7.6% on average in the past 30 days, with the Nasdaq leading the way at 11.52%.
   

2. Investors switching/reallocating positions during the start of the calendar year.
   

3. The low volume of selling and an accumulation of short positions from Bitcoin’s previous 2 months of consolidation.

Expect more downside, but the bottom is somewhere there this year: Sani Hamid.

Despite this uptick, the message conveyed by Mr. Sani remains the same: equity markets are expected to pose more downside as the Fed keeps rates higher for longer.

He believes that the S&P500 index could fall another 10-15% to 3,400 points. Translating the figures to Bitcoin, that equates to its November 2022 low of $15,500, unless the crypto market experiences another black swan event.

As for the bulls hoping for Bitcoin to decouple from the US equity market, it may still be a pipe dream because there are simply no reasons for Bitcoin to venture on its own path. The other (logical) consideration to have is for the stock market to continue its current rally, but that too may be a far stretch.

For the stock market to show growth, companies must demonstrate improvement in their earnings and consumers must be willing to pay a premium for each dollar of earnings. These two factors alone present a significant challenge, particularly during a period when interest rates are absurdly high.

The ringgit is strong because the US dollar has weakened significantly.

The chart below is self-explanatory. When placed on top of one another, it becomes obvious that the ringgit’s trajectory is closely linked to the US dollar index, not to the appointment of new politicians.

The question now boils down to why the dollar has fallen off so hard in the past 2 months. But allow me to take a step back and talk about why there was a dollar rally in the first place.

2022 was a year driven by inflation, mainly due to the soaring prices of commodities. Since the dollar effectively used for world trade, the higher prices of oil contributed to the strength of the greenback.

There were also fears of a dollar shortage as the Fed continuously tightened the monetary policy and withdrew liquidity from the market. The head start which the Fed had in raising interest rates meant that other central banks were forced to play “catch-up” with the Federal Reserve.

The difference in interest rates alone, in 2022, caused a major shift away from other currencies and into the dollar.

But now, investors are moving towards emerging markets (China, Malaysia, etc).

Combined with the declining rate of inflation, slowing pace of interest rate hikes, and the start of a new calendar year, the dollar fell pretty much like a stone.

Despite this, the future prospects of the dollar remain positive. It has the potential to recover from its current state.

When I raised the question of “Where do you think the dollar will be in the next few months?” to Mr. Sani, he responded pretty confidently and said that we may be near the bottom.

The answer from him surprised me a little, but his justifications quelled my doubts. With China’s grand reopening, he mentioned, there could be a shortage of oil, in which the dollar’s demand will rise since it is driven by commodities.

The other aspect to look at a comeback for the dollar is the pace of tightening from other central banks. Currently, some of the central banks (like Bank Negara Malaysia) have already begun pausing interest rate hikes and are even looking to reverse course.

Should the US keep rates higher for longer (and they will), the widening gap in interest rates will secure more capital flow back into the dollar.

The Federal Reserve is expected to hike rates by 25 basis points on Feb 1.

The outcome of the February Federal Open Market Committee (FOMC) meeting may have already transpired as you read this. Nonetheless, the markets were already anticipating the Fed to lower its rate hikes to 25 basis points, so there should be no adverse effect if it does so.

The more pressing issue is determining the peak of interest rates for this year. Investors predict that the Fed will reach a peak of 4.75-5.00% and then pivot, however, the Fed has indicated that the peak will be higher, with no pivots in sight.

I recently posed an interesting question to Mr. Sani regarding the possibility of the Fed pausing its interest rate hikes, which he answered comprehensively.

The Federal Reserve has four main ways of reducing inflation, although it has limited control over two of them:

1. The pace and size of interest rate hikes.

2. Withdrawing liquidity from the market by selling assets on its balance sheet (quantitative tightening).

3. A decline or drop in the stock market, as equities contribute to wealth and ultimately inflation.

4. The strengthening of the US dollar, which lowers imported inflation and increases the cost of exports.

Currently, factors (3) and (4) are not met, as we have seen a resurgence in the stock market and a steep decline in the dollar index. This puts added pressure on the Fed to continue with rate hikes, albeit at a smaller rate.

That’s all for this week’s newsletter!

Disclaimer: I am not a financial advisor. This newsletter is based on my own analysis and research. Do not take any of it as financial advice.

*This newsletter was written at 9.30 AM on 30 January 2023 and completed at 3.30 PM the same day. To get early access to our newsletter, be our patron for as little as $1/month!