Pre-FOMC

Key Concepts

• FOMC Meeting: Federal Open Market Committee meeting, where the US Federal Reserve decides on monetary policy, including interest rates.
• Rate Cuts: Reductions in the target for the federal funds rate, intended to stimulate economic activity.
• Risk Management Rate Cuts: Interest rate cuts implemented proactively to mitigate potential economic downturns, rather than in direct response to severe negative data.
• Neutral Rate: The theoretical interest rate at which monetary policy is neither expansionary nor contractionary.
• 2-Year Yield: The yield on a U.S. Treasury security with a two-year maturity, often used as a proxy for market expectations of future interest rates.
• Fed Funds Rate: The target interest rate set by the Federal Reserve for overnight lending between banks.
• Restrictive Interest Rate: An interest rate that is high enough to slow down economic growth and curb inflation.
• Tailwinds from AI: Positive economic forces driven by advancements and adoption of artificial intelligence.
• Magnificent 7: A group of seven large-cap technology stocks that have significantly driven market gains.
• Index Funds: Investment funds that track a specific market index, offering diversification.
• Quantitative Tightening (QT): A monetary policy tool where a central bank reduces the size of its balance sheet by allowing assets to mature without reinvesting the proceeds, thereby withdrawing liquidity from the financial system.
• Quantitative Easing (QE): The opposite of QT, where a central bank injects liquidity into the financial system by purchasing assets.
• Bitcoin Dominance: The market capitalization of Bitcoin as a percentage of the total cryptocurrency market capitalization.
• Altcoins: Cryptocurrencies other than Bitcoin.
• All Bitcoin Pairs: The trading pairs of altcoins against Bitcoin (e.g., ETH/BTC, SOL/BTC).
• Dual Mandate: The Federal Reserve's objectives of maximizing employment and maintaining price stability (low inflation).
• Hard Landing Recession: A severe economic downturn characterized by a sharp increase in unemployment and a significant contraction in economic output.
• Balance Sheet: A financial statement that summarizes a company's or central bank's assets, liabilities, and equity at a specific point in time.
• Fractal: A pattern that repeats itself at different scales, often used in technical analysis to suggest similar market behavior.
• Topping Process: A gradual period where an asset's price reaches its peak and begins to decline, often over an extended period.
• Bottoms are Events: Market bottoms are typically sharp and sudden occurrences.
• Order Books: Records of all outstanding buy and sell orders for a particular asset on an exchange.

Upcoming FOMC Meeting and Market Implications

The upcoming FOMC meeting on October 29th is a significant event for financial markets, including risk assets like Bitcoin. The market widely anticipates a rate cut, with the Federal Reserve expected to follow suit. This expectation is driven by a lack of recent, alarming economic data, particularly concerning the labor market and inflation, which are key inputs for the Fed's decisions.

Rate Cuts as Risk Management

The Fed's current rate cuts are characterized as "risk management rate cuts," as articulated by Chair Powell. This means they are not reacting to a sudden economic crisis but are proactively taking steps to extend the economic runway and prevent potential downturns. This strategy mirrors actions taken in 2024, with a September rate cut already implemented and another expected in October, likely followed by one in December. The current cycle's rate cuts have been 25 basis points, unlike the 50 basis point cut in September 2024.

Interest Rate Landscape and Economic Impact

Discussions around the neutral rate, estimated by some to be around 3%, are ongoing. The 2-year Treasury yield, currently at approximately 3.5%, is used as a close approximation for this neutral rate. The anticipated rate cut will bring the Fed Funds Rate down to 4%, which is still considered theoretically restrictive, meaning it could still exert pressure on certain economic sectors. Despite this, the economy is experiencing tailwinds from AI, which has been a primary driver of gains in major indices like the S&P 500. This concentration of gains in a few leading companies, such as the "Magnificent 7," is a recurring theme in market cycles, making index funds a prudent choice for most investors.

Historical Context of Rate Cuts and Market Performance

Historically, rate cuts have generally been constructive for markets. While there have been instances where markets declined during rate-cutting cycles (e.g., the financial crisis), periods like the 1990s saw markets trending higher throughout rate adjustments. The key differentiator is the reason for the rate cuts. Aggressive cuts during a period of skyrocketing unemployment, as seen in past crises, tend to coincide with market downturns. However, in the current cycle, the unemployment rate has been rising in a manner that aligns with the Fed's objective of loosening the labor market and reducing wage inflation. The Fed's primary concern is to avoid a sharp, uncontrolled surge in unemployment.

The Role of the 2-Year Yield and Fed's Reactivity

The 2-year Treasury yield is a strong indicator of the Fed's future actions, as the Fed Funds Rate historically follows its trajectory. The current 2-year yield suggests the Fed should lower rates, which they are expected to do. This highlights the Fed's reactive nature, responding to market signals rather than dictating them. The speaker emphasizes that criticizing the Fed is easy, but few would have had the conviction to raise rates to 5.5% in 2022, a move that was met with significant skepticism.

The Balance Sheet and Quantitative Tightening (QT)

Beyond interest rates, the Federal Reserve's actions regarding its balance sheet, specifically Quantitative Tightening (QT), are a crucial focus. The Fed has been reducing its balance sheet since Q2 2022, with adjustments made to slow the pace of reduction. This is also framed as a risk management strategy to stabilize liquidity and boost confidence, potentially in response to emerging stresses in the financial system, such as liquidity issues in money market funds.

Scenarios for QT Ending

The timing of the end of QT is uncertain, with some banks predicting an announcement soon (e.g., JP Morgan) and others expecting it in early 2026 (e.g., Goldman Sachs).

• Continuing QT: The speaker argues that continued QT might be more bullish for Bitcoin than its immediate cessation. Historically, altcoin pairs against Bitcoin have bottomed out when QT ended. However, if QT continues, liquidity is expected to flow from altcoins to Bitcoin, supporting Bitcoin dominance.
• Ending QT: If QT ends, it could lead to a rotation away from Bitcoin, potentially questioning the integrity of the current bull market. In 2019, Bitcoin topped out a few months before QT ended, and ignoring the pandemic, Bitcoin experienced a roughly 50% decline.

Impact on Altcoins and Bitcoin Dominance

The speaker's analysis suggests that regardless of whether QT ends or continues, altcoins are likely to devalue against Bitcoin.

• During QT: Liquidity tends to flow from riskier altcoins to the perceived safety of Bitcoin, increasing Bitcoin dominance.
• Post-QT: While ending QT might offer some relief to altcoins, if Bitcoin continues its upward trajectory, it could still draw liquidity away from altcoins, as seen in previous cycles. The conditions for a broad "altcoin season" require Bitcoin and Ethereum to reach new all-time highs and sustain them, which is not guaranteed.

The current market environment, characterized by high interest rates and QT, favors "blue chip" assets within each class. This is why Bitcoin has performed well while many altcoins have struggled, as indicated by the declining advanced decline index for the top 100 cryptocurrencies.

The 2023-2025 Bull Market Drivers

A key observation is that the Bitcoin bull market from 2023 to the present has been fueled by a confluence of factors: a pause in interest rates, subsequent rate cuts, ongoing QT, and rising Bitcoin dominance. This pattern mirrors the conditions observed in 2019, albeit for a longer duration.

Potential Market Top and Future Outlook

The timing of QT's end could be instrumental in forming a thesis for the market's trajectory in 2026. If QT ends in early 2026, it could align with a potential Bitcoin top in Q4 2025, fitting the historical pattern of market cycle tops occurring in the fourth quarter of a post-halving year. Conversely, if QT ends immediately, it could signal a more advanced market stage, potentially leading to a more pessimistic outlook based on market cycle ROI charts.

The speaker concludes that while the Fed's interest rate decisions are important, the future of QT and its implications for liquidity and asset rotation will be the more significant topic in the coming months. The current strategy for investors, especially in crypto, is to focus on Bitcoin due to its relative stability and potential for upside, while altcoins face continued devaluation risk. The thin order books in crypto markets make them susceptible to significant price swings.