Highlights

1. The advanced subject of Futures Trading, Gate learn, aims to help traders establish a professional futures trading system, forming a framework for contract thinking from three aspects regarding investment philosophy, contract tools, and trading system.

2. This issue is subjected to introduce “How to look at the cyclical volatility of the cryptocurrency market from a macro perspective”, and introduce the basics of the Federal Reserve, how monetary policy affects markets and how investors should respond to it.

I. What is the Fed?

1. Background
   For historical reasons, the United States was not impressed with the concept of a “central bank” in the early days of its founding, which led to repeated failures in the creation of such central banks. Without the central bank, the financial industry expanded blindly and disorderly, and bank runs were always the case, leading to the frequent financial crisis.
   By 1907, the Financial Panic finally enabled people to realize that the United States needed a central bank to assume the role of “lender of last resort”. However, there was a great deal of disagreement about the nature of a central bank, so the famous “Aldrich Plan” inevitably aborted. While the plan has laid a solid foundation for the creation of the Fed. After comprehensively considering the anti-capitalist and anti-government monopoly claims of different groups, the government decided that the Federal Reserve Act adopted the dual organization structure of federal government and non-profit.
   In 1913, Federal Reserve Act was signed by President Woodrow Wilson. On Aug. 10, 1914, the U.S. Federal Reserve System was officially in operation, marking the formal establishment of the U.S. Central Bank.

2. Organizational Structure and Duties
   Shortened from the Federal Reserve System, the Fed is the central bank of the United States. Of all the central banks, the Fed is unique. Since the central banks of many countries are entirely government departments, the Federal Reserve adopts the public-private partnership system characterized by the dual organization structure of federal government and non-profit.
   According to the official introduction of the Federal Reserve, there are three core functions of the Federal Reserve:

• Controlling inflation and maintaining price stability
• Promoting maximum employment
• Serving U.S. Economic Development

The most important monetary policy undertaken by the Fed is to open market operations. The Federal Open Market Committee (FOMC) is also responsible for adjusting the interest rate, and deciding the asset purchase facility which was closely concerned by the market.

II. How Fed monetary policy affects the cryptocurrency market

1. The correlation between the U.S. stock market and the cryptocurrency market
   According to Google Finance data, the cryptocurrency market shows a high correlation with the trend of the US stock market. From the beginning of 2022 to date, BTC lost $28,719, or 60.17%, while the US stock Nasdaq fell by 25.52%. As can be seen from the line chart, the price trend of the two is almost synchronous, and the low, high, and market turning points are almost on the relevant timeline.
   The Fed’s impact on the US stock market is the impact on the cryptocurrency market. The Fed began a rate hike cycle in March this year to deal with high inflation and has raised interest rates five times in a row, accumulating 300 basis points.

2. Looking back, the impact of the Fed’s interest rate raise and balance sheet reduction on financial markets in history is as the following:
   
   
   
   Obviously, global financial markets have shaken violently under the interest rate rice cycle, with global stock markets and risk asset markets such as crypto assets falling in general.
   It is commonly known that high-interest rate markets and tightening policies are very bad for risk assets. We know that in a low-interest rate environment, investors will get money at a relatively low cost and leverage at a lower consideration to get a higher return on risk, thus pushing up the price of risk assets. As interest rates rise and liquidity is withdrawn from the market, the asset bubble that was previously pushed up by leverage will burst and investors will become more risk-averse, and capital will start to flow to risk-averse assets. As a result, the high-risk market, represented by the stock market, will fall, and the emerging cryptocurrency asset trading market, which is regarded as a speculator’s paradise because of the global 365*24-hour trading and lack of regulation, will naturally bear the brunt.
   As mentioned by Zhang Lei, the founder of High Tide Capital, in his book Value, “every round of bull market originates from an easing of liquidity and ends in a liquidity crunch”. It is foreseeable that the crypto-asset trading market will continue to represent the downward trend of shocks for the next year or so. The risks faced by short-term traders cannot be ignored, and long-term investors also need more time to look for a better trading moment.

III. How Investors Can Cope with the Cyclical Fluctuations of the Market

Before formally starting to share, we should be clear that the entire market is constantly changing, and the economy also represents the recovery, boom, bust, and recession cyclical cycle. Only by understanding the current stage and being familiar with the properties of investment instruments can you have certain coping strategies to ensure sound and profitable investments.
To facilitate the understanding of the current stage, we should first get to know the concept of the Merrill Lynch Clock. The Merrill Lynch clock is a set of asset allocation theories proposed by Merrill Lynch, which mainly describes the corresponding investment strategies under different economic cycles. That is, to tell investors, “what stage is currently in, and how to allocate assets in this stage”.

According to the economic growth rate (GDP) and inflation rate (CPI), the Merrill Lynch clock divides the economic cycle into four stages, respectively, recovery, overheat, stagflation, and reflation. When the economy is in the four stages of a cyclical cycle, the portfolio of asset allocation is also followed by changes.
According to Hong Hao, managing director and head of the research department of Bank of Communications International, “the Fed raised interest rates by 25 basis points, the U.S. high inflation is a drop in the bucket, data are indicating that the U.S. economy is moving towards the stagflation phase. This phase is characterized by a decline in economic growth, but price levels remain high. The priority of investment allocation is: cash > commodities > bonds > equities. Simply put, risky assets fall sharply in this phase, and holding cash or holding shorted assets is the main priority.

Then how should investors as crypto assets allocate their assets in that phase? According to Merrill Lynch clock asset allocation theory, the priority is: cash/futures shorting assets, ETFs, wealth management products, and commodities. Simply speaking, it is to hold USDT cash assets or hold low times futures to preserve or increase asset value in the case of an overall bearish market. At the same time, a small portion of assets can be invested in staking, lending finance, and liquidity mining to earn stable low-risk returns. Since the spot market at this stage spot market remains a downside risk, the possibility of buying a long-term set is relatively large, it serves as the last option and must be cautious to buy.

Both futures trading and leveraged trading can meet the demand of shorting and preserving value in bear markets, and both can improve the efficiency of capital use through leverage. However, futures trading has won the favor of more crypto asset investors in terms of product experience, such as no steps of borrowing and returning coins, optional product types of USTD-M perpetual contracts, standard money perpetual contracts, delivery contracts, and easier operation process.
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IV. Summary

This issue explains the intrinsic relationship between the Fed’s tightening policy and the cryptocurrency market from the macro level, which is important to grasp the cyclical bull and bear fluctuations of the crypto market. Only by following the laws of the market, and operating with the market dynamic can you achieve solid investment returns.
For more trading practice, please go to the Gate Futures, register a Gate.io account, and start trading crypto futures now!

Disclaimer:
This is for your reference only. The information provided by Gate.io above is not investment advice and is not responsible for any investment you may make. The information regarding technical analysis, market judgments, trading tips, and trader sharing may involve potential risks, investment variables, and uncertainties, and this issue does not provide or imply any opportunity for guaranteed returns.