Key Points
- Bitcoin broke through the band of support at 110K, warning of a correction.
- The secured overnight financing rate (SOFR) spiked above the interest rate paid on reserve balances at the Fed, warning of a sharp contraction in liquidity in financial markets.
Better buckle up. Bitcoin serves as the canary in the coal mine for financial markets.
A breach of the band of support between 108K and 110K warns of a correction that is likely to spread to major stock indices such as the Nasdaq and S&P 500.
The S&P 1500 Regional Banks Index fell sharply this week as markets were spooked by three large defaults, which appear to involve fraudulent disclosure. A peak below the 50-day weighted moving average and a Trend Index peak below zero both warn of selling pressure.
This week everyone is beared up on regional banks (again). Zions lost $50mn on a loan. A loan equal to 0.08% of their loan book. Yes, less than 0.1%. There have been a series of fraudulent loans uncovered and investors are worried these are signs of a bigger problem. The cockroach metaphor.
Yes, it’s scary for 3 fraudulent loans to come up all at once (Tricolor, First Brands and the Zions loan), but rather than it being a systemic problem is it possible that after the Tricolor loan went bad, every bank immediately began scrubbing every loan for irregularities and that is why these disclosures are coming up so quickly? On a practical basis it’s hard to have a systemically high level of loans be fraudulent. Possible, but hard. Bank loan underwriting has been around for a long time, and it’s pretty stringent, which is why private credit is doing so well. If you have an irregular profile and want a risky loan, go to a private credit fund, not a super regulated regional bank. (YWR)
Financial Markets
The secured overnight financing rate (SOFR) spiked to 15 basis points above the rate paid to commercial banks on their reserve balances at the Fed (IORB), indicating that large banks are reluctant to lend in the repo market despite the collateralized security.
SOFR is the rate charged by banks on overnight borrowing secured by Treasury securities as collateral (repo).
Banks usually are comfortable lending in the repo market, and the SOFR typically trades at a discount to IORB because of the preference for high-quality UST collateral. The SOFR spike above the IORB warns that the financial markets are under stress, with a sharp contraction in liquidity as lending dries up.
The Fed will likely intervene, injecting liquidity to calm the markets, and a rate cut at the next FOMC meeting on October 28-29 is now almost inevitable.
Gold
Gold hesitated at $4,300 per ounce and will likely retrace to test support. A correction that respects support at $4,000 would signal a fresh advance with a target of $4,600.
Conclusion
Be prepared for a volatile week ahead.
The Bitcoin breach of support at 110K and a spike in the secured overnight financing rate (SOFR) warn of a sharp contraction in liquidity. We expect a sharp fall in stocks unless the Fed intervenes to inject liquidity before markets open on Monday.
Acknowledgments
- CoinDesk: Bitcoin
- YWR: Stupidly Bullish
Colin Twiggs is a former investment banker with almost 40 years of experience in financial markets. He co-founded Incredible Charts and writes the popular Trading Diary and Patient Investor newsletters.
Using a top-down approach, Colin identifies key macro trends in the global economy before evaluating selected opportunities using a combination of fundamental and technical analysis.
Focusing on interest rates and financial market liquidity as primary drivers of the economic cycle, he warned of the 2008/2009 and 2020 bear markets well ahead of actual events.
He founded PVT Capital (AFSL No. 546090) in May 2023, which offers investment strategy and advice to wholesale clients.