Bitcoin, Ether Erase Monday's Gain As Hawkish Fed Trade Returns

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Risk assets, including cryptocurrencies, traded lower early Tuesday in a sign of renewed nervousness over the Federal Reserve’s (Fed) impending liquidity tightening.

Forbes data shows bitcoin, the leading cryptocurrency by market value, at $562 billion, fell by over 5% to $29,300, reversing Monday’s relief rally, which saw prices rise from $29,800 to $31,700. The bounce was triggered in part by China’s decision to roll back economically-damaging covid lockdown restrictions.

Ether, the native token of Ethereum’s blockchain, tracked bitcoin lower, falling 5% to $1,725. The broader crypto market wilted, with the newly launched Terra Luna Classic’s LUNC token, open-source blockchain Neo’s NEO cryptocurrency, and Dfinity Foundation’s internet computer (ICP) token taking a bigger hit than bitcoin and ether. There were no winners at press time.

The Asian and European stock markets dipped early today and the futures tied to the S&P 500 declined by over 0.4%. The yen fell to a fresh 20-year low of 133 per dollar after Bank of Japan (BOJ) governor Haruhiko Kuroda ruled out monetary tightening, highlighting the widening divergence from the Fed’s aggressive tightening plans. The yen has been a poster boy of the Fed trade, given the BOJ’s commitment to continue printing money amid rising inflation worldwide. This year, the yen has dropped 15%, a substantial slide for a developed nation currency.

The primary source of risk aversion was perhaps the return of the so-called hawkish Fed trade, where investors buy dollars and sell interest-rate-sensitive assets like stocks, emerging technology assets such as cryptocurrencies and relatively low-yielding currencies like the Japanese yen, on expectations that the Fed will suck out liquidity from the system.

These fears have dominated the market sentiment since November and have come back into focus with the U.S. nonfarm payrolls report released by the Labor Department pointing to continued labor market strength and low odds of the economy dipping into a recession anytime soon.

The data essentially validated the Fed’s long-held belief that it would be able to close the liquidity tap without leading to a hard landing or pushing the economy into a recession – a period characterized by consecutive quarterly contractions in the growth rate – and has weakened the case for the Fed to pause tightening in September. Perhaps that led to investors selling risk assets again.

Stocks and cryptocurrencies breathed a sigh of relief in the second half of May after Raphael Bostic, the president of the Atlanta branch of the Fed, opened the door to the possibility that the Central Bank might pause rate hikes in September. The hopes for a pause strengthened after data released on May 28 showed the personal consumption expenditures (PCE) price index, the Fed’s preferred measure of inflation, rose 0.2% in April, the smallest gain since November 2020.

Additional bearish pressure for risky assets likely stemmed from expectations of aggressive unwinding of stimulus by the European Central Bank (ECB), which has remained dovish until now despite rising inflation across the common currency area.

According to Reuters, Bank of America expects the ECB to hike interest rates by 150 basis points this year, including 50 bps moves in July and September. The central bank’s benchmark interest rate currently stands at -0.5%.

Lastly, caution ahead of a highly anticipated US Senate proposal to bring the cryptocurrency industry under federal oversight may have had investors take some risk off the table. Sponsors, Senators Cynthia M. Lummis and Kirsten Gillibrand, are expected to table their bill titled the Responsible Financial Innovation Act later today.

From the technical analysis standpoint, the crypto market valuation is flirting with crucial support, which, if breached, could pave the way for more profound losses.

The daily chart shows the crypto market cap has formed a symmetrical triangle over the past three weeks, marking a consolidation between converging trendlines. This structure results from both bulls and bears being unwilling to lead the price action. A big move is usually seen in the direction in which the price squeeze is eventually resolved, meaning a breakout leads to price rallies while a range breakdown draws more sellers to the market.

At press time, the total market cap traded around the lower end of the triangle. A UTC close under would confirm the breakdown, creating room for a drop toward the May low of $1.082 trillion.

On the flip side, a breakout would open the doors to resistance at $1.489 trillion, marked by the Jan. 24 low.