Cryptocurrencies

Q1 2021 set to mark increased risk – Cryptocurrencies

The resurgence of the virus, the return of economic restrictions and deadlines, the extreme inflation of asset prices, are all cumulative factors of risk in the first quarter of 2021. An impact on the price of assets could be manifested, including cryptocurrencies. The first quarter of 2021 should therefore be anticipated under the best possible conditions.

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A chaotic first quarter of 2021?

The economy under strain

We are far from the end of the crisis promised by many governments in the summer of 2020. Several elements tend to show a strong economic risk for the first quarter of 2021:

  1. The maintenance of sanitary restrictions, which will worsen the recession and severely curtail the recovery. The longer the economic restrictions last, the less intense the economic rebound that will follow.
  2. The presence of very important deadlines in early 2021 for many businesses and states. To this must be added the monetary risk. We could see liquidity strains from mid-January, due to the economic and monetary context.
  3. A cumulative risk. The beginning of 2021 will be marked by the addition of a health risk and an economic risk, which is very dangerous. State aid is not everything, and cash flow difficulties become persistent in the present and cumulative in the future.

2021 should therefore open on a still difficult start to the year. Spring could then mark a drop in risk. Although health improvement from the vaccine is not expected until the second half of the year. If the first quarter results in a continuing recession, the economic recovery expected thereafter could be very severely affected. Which, obviously, would be a source of economic and financial frustrations major.

Financial markets under strain

St Louis Financial Stress Index. Source: FRED.

Market stress increased sharply between mid-January and mid-March 2020. Since then, liquidity injections have given hope to the markets, which have seen their stress very strongly drop. This stress has eased further with the US election and the announcement of a vaccine. This context triggered a very strong rally bullish on cryptos.

For the past few weeks, market volatility and stress has stagnated at lows. Proof of the indecision for the moment serene of the markets, in a context of disconnection from the fundamentals. Indeed, while the economy is experiencing a recession three times greater than that of 2008, the markets are reacting positively. The first one expectation of this bull market is that of an economic catch-up effect in 2021.

If this catching-up does not take place due to worsening economic fundamentals, then the markets could experience tremendous frustration. A worsening of economic fundamentals in the first quarter of 2021 would be a clear sign of (strong) tensions in the markets.

A threat to the rise of cryptocurrencies?

Explain the increase in recent months

In March 2020, financial stress is at its highest. Risk aversion increases and Bitcoin (BTC) hits major low. In the spring, the financial stress is thwarted by the massive injections of liquidity. Which allows a rebound of almost all assets including Bitcoin.

To this, he adds the two years that passed between the speculative high of late 2017, and early 2020. Over the same period, the crypto industry emerged: the total number of crypto users has been multiplied by more than 3, the BTC capitalization has been multiplied by more than 15, while businesses have multiplied by the hundreds.

When financial stress eased in summer 2020 (also following the Halving), agents have completed a long bottoming process, due to extremely powerful fundamentals. The amplifying element to this naturally uptrend was the announcement of giants like PayPal, Facebook, JPMorgan, etc.

The sharp increase is accompanied by a very favorable financial context (little stress, liquidity, vaccine, etc.). This has allowed a massive influx of capital into cryptocurrencies. While Bitcoin is gaining more than 180% in 2020, its capitalization has multiplied by almost 2.7 to exceed that of the largest companies (Bank of America, LVMH, etc …)!

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Market risks

Demand, especially in relatively speculative markets, is very sensitive to liquidity pressures. As we have seen, the start of the year could mean economic and monetary tensions, which is often very unfavorable for cryptocurrencies. In a context of a strongly upward trend, we must be careful that the first quarter of 2021 does not result in a halt in the rise.

This risk is common to all markets: stocks, cryptos, and even metals. In March 2020, almost all markets fell sharply, above all respecting liquidity logic. This risk at the start of 2021 could therefore be amplified by greater frustration, due to current market expectations. Markets have never been so out of touch with reality. Which also shows that markets react to expectations rather than fundamentals. In other words, the wait-and-see nature of the market is a risk factor in the event of a rollover.

However, the risks of the first quarter on cryptocurrencies can be partly offset by the many actions of institutionalization to come (Facebook, PayPal, etc …). Although the market seems to have already included in the prices these expectations.

A questioning of the market in 2021?

Give 2021 market characteristics

First of all, we can expect:

  1. A increase in bond risk. This is one of the main threats over 2021 due to the maintenance of very highly structural fiscal deficits and the heavy deadlines ahead. If these risks are confirmed, we could initially see a negative impact on the markets. However, in the medium term, a positive effect may emerge, as was the case after 2010: bonds compete less with other markets.
  2. A financial indecision. The recovery, if it is as strong as the expectations made by the market, will not be uniform. Certain territories will be very heavily impacted, which will be reflected in the price of assets. Moreover, the fact that the markets are already several years ahead on their real value remains a threat in the event of a market reversal.
  3. Of powerful crypto fundamentals despite market risks. Although Cryptos May Face Market Risks, 2021 Should Confirm a year of strong democratization. The stake is to know if this will be reflected (or not) in the prices which have already increased very strongly.

The markets in 2021 may therefore be relatively less volatile, but even more frustrated than they were in 2020. Some markets are expected to decorrelate more sharply from widespread changes in assets. The presence of generalized variations in all assets also shows the wait-and-see nature of the market, more than its “reactionist” nature to fundamentals.

The monetary threat to be considered?

The 2021 growth differential between regions, the massive injections of liquidity, are all factors that may play in favor of a diversion of traditional currencies. In 2020, we saw a sharp fall in the dollar, and a rise in the euro despite massive monetary injections. These injections make cryptos prefer currencies among many investors. The significantly winning currencies are also currencies like the Yuan. Exactly like in 2008 with even stronger fundamentals this time around.

2021 could reflect a drop in confidence in traditional currencies, which in part would be a bullish factor in cryptos. The issue will then be whether or not currencies like the dollar are able to withstand the maintenance of high economic risk.

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Conversely, a monetary risk could reflect an amplified fall in confidence, which would be a strongly bearish factor in many markets. The intensity of future monetary policies, the evolution of the economic situation, are all elements to be taken into account in its strategies.

The first quarter of 2021 should reflect continued economic, monetary and therefore financial risk. If these tensions are confirmed, the markets should react negatively due to current investor expectations, and the outlook for the first quarter. It is therefore to be expected that early 2021 will face an overall increase in risk. Therefore, the rise in cryptocurrencies could be affected more or less strongly. The important thing will therefore be to remain particularly cautious in the face of a possible trend reversal.

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