Paribus. After the storm.

If the global financial system is an ocean and the ships on it represent the different markets, crypto would be the equivalent of a small boat tossed around by the storms we’ve experienced this year. Whatever happens with the development of the technology it’s impossible to avoid the effects of global shifts as we saw last week with the Federal Reserve’s latest rate hike.

Even though the news from the Fed was exactly what markets had anticipated and priced in, the response was turbulent which caused more moves to the downside. The reason for this wasn’t so much the content of the Fed’s announcement but its timing.

As soon as the latest rate hikes were announced traders could quickly move their positions to get ready for the end of the year. The rapid rebalancing of their portfolios is what caused the market volatility, not the predicted recession.

Analysts liken the financial snapshot taken at the end of December to a family portrait that every company has to prepare for. Those with exposure to the markets rebalance their portfolios to make their investments seem strong, which usually means low risk, low yield assets.

At the start of January many portfolios once again rebalance to include more risk-on investments that provide the yield companies are looking for. In the meantime the media will have a feeding frenzy, rehashing all of their previous articles asking if cryptocurrency can survive.

The most important factor for the crypto market in the new year is the macroeconomic outlook. The market looks set to be affected once again by events in China, however this time it should be to the upside rather than the downside.

A few weeks ago the G20 met in Bali and it was preceded by a face to face between the Chinese and US Presidents, Xi Jinping and Joe Biden on 14th November. It was notable that the tone of the meeting was cordial with both countries agreeing on the need for cooperation and harmony.

At the time China was still enforcing its zero-covid policy of city-wide lockdowns and their economy was suffering badly. This allowed the US time to try and correct its own economy while also helping to finance Ukraine’s armed forces.

On November 17th, Xi Jinping dramatically changed course on his zero covid policy and announced that the government would begin to relax restrictions. The timing was crucial. By removing the restrictions at this point several waves of covid will push through the population over the new year period when their manufacturing industry is due to enter a seasonal slowdown. This should enable the Chinese economy to bounce back quickly in Q1 2023.

One week after President Xi announced the abandonment of his zero covid policy, the US pivoted on its approach to avoiding a trade war. They announced further restrictions on Chinese technology sold in the US, effectively banning Huawei and others from their domestic market.

The following week President Biden took the world by surprise when he announced that he would be willing to speak to Vladimir Putin with a view to ending the war in Ukraine. Although it was heavily caveated this was the first indication the US and its allies were looking to negotiate a resolution to the conflict.

Most commentators have seen these events as separate, unrelated developments. However, when viewed together it indicates that the two largest superpowers are positioning themselves to enter another growth phase in 2023. If China succeeds in allowing covid to run quickly through their population and get back to normal in March, can the US afford to keep financing a war in Ukraine and also plunge its own economy into recession?

Two weeks ago President Xi attended a 3-day summit in Saudi Arabia to strengthen bilateral ties and improve the two countries’ trade relations. A key outcome of the talks was the agreement that China would pay for part of the oil it imports from Saudi Arabia in Chinese Yuan, not US Dollars.

According to a member of the Saudi Arabian government we spoke with, the country would prefer to strengthen their ties with the US, but the fact that Joe Biden is a Democrat makes this difficult. They said, “Traditionally we have good relations with Republican Presidents and bad ones with Democrats. In the present geopolitical landscape it makes complete sense for us to strengthen ties with China.”

If the US economy plunges headlong into recession, its dollar remains high, and it continues to have to print money to finance the war in Ukraine, trade deals with China will look all the more appealing to other nations. For these reasons there’s increased political pressure on the Federal Reserve to reduce their rate hikes, and position the economy for a soft landing.

If that happens the outlook for 2023 will start to look brighter. It may come down to a choice between living with inflation at levels above their 2% target or living with China as the next global economic leader. Neither are particularly palatable but at least the early part of next year will set the scene for the rest of 2023.

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