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April 12, 2021

Powell is optimistic, digital currencies on the agenda, and a bond market test.

Inflection point

Federal Reserve Chair Jerome Powell said that the U.S. economy is at a place where growth and job creation could start coming in much more quickly. Powell, speaking on CBS's "60 Minutes", said the "outlook has brightened substantially." The interview was broadcast yesterday, but recorded on Wednesday, the day before he told an IMF panel that he is not worried about inflation risks. 

Digital 

Powell also said that the central bank was involved in a large-scale research project on a digital dollar, but that any decision to introduce one was for Congress and the public. Digital currencies are on the mind of U.S. policy makers at the moment, with officials at the Treasury, State Department, Pentagon and National Security Council upping efforts to understand the implications of a digital yuan, according to people familiar with the matter. Some officials are concerned it could be the start of a long-term bid to replace the dollar as the world's reserve currency. In non-aligned digital currencies this morning, Bitcoin traded close to record highs above $60,000.

Bond test 

With Powell sticking to the script on maintaining accommodation even as the U.S. economy improves, support for the bond market seems likely to remain strong for now. There is a test of that today with the sale of $58 billion of three-year notes and $38 billion of 10-year bonds. Tomorrow, after much anticipated inflation data, there is a sale of 30-year debt. 

Markets slip

Global equities are not getting the week off to a great start, with gauges giving up some ground. Overnight the MSCI Asia Pacific Index slipped 0.7% while Japan's Topix index closed 0.3% lower. In Europe, the Stoxx 600 Index had dropped 0.2% by 5:50 a.m. Eastern Time with declines led by retail and travel stocks. S&P 500 futures pointed to a lower open, the 10-year Treasury yield was at 1.655%, oil gained and gold slipped. 

Coming up... 

The U.S. March budget statement is at 2:00 p.m. The Biden administration will hear from companies vying for scarce semiconductor chips today as officials try to figure out how to relieve the shortage that has idled automakers worldwide. Boston Fed President Eric Rosengren speaks later. 

What we've been reading

Here's what caught our eye over the weekend.

And finally, here's what Joe's interested in this morning

Everybody knows by now that Wall Street is getting increasingly interested in Bitcoin. It was on the cover of Barron's this weekend. And of course this is the week that Coinbase is going public. However, alongside all this people are increasingly talking about a specific Bitcoin trade that offers the appearance of very easy money. At issue is the extreme contango in the Bitcoin futures curve. On the CME -- one of the most straightforward avenues for institutional traders to go long Bitcoin exposure -- prices trade at a significant premium to spot.

So for example, at the close of trading on Friday, Bitcoin spot was just over $58,300, whereas the December 2021 CME contract was over $63,000.

What this means is that in theory (I stress, *in theory*) you could go long spot Bitcoin, while shorting the December future, and if you just wait for the two to converge then that's an easy 8% return in 12 months. That's a lot in a world where risk-free trades pay you nothing these days. You can amplify it even more if you have leverage. And in fact the closer months offer even more juice.

Anyway, this is clearly starting to get the attention of some on Wall Street. It was a topic of conversation I heard about last week and then on Friday JPMorgan's rate derivatives strategist Josh Younger put out a report on the steepness of the Bitcoin futures curve. He calculated that as of last week the June CME contract was offering a 25% annualized yield relative to spot.

So then of course the question is, if this is just sitting there, why hasn't the spread been arbed away. Of course, contango is a frequent feature in commodity futures curves but with, say, oil, you have storage costs if you buy the spot oil and carry it all the way to the out months. (We saw this to an extreme degree almost a year ago, when the price of short-term oil went negative because it was so costly to hold.) Of course Bitcoin doesn't have carrying costs, but it has all kinds of other issues. The biggest, as Younger notes, is that there's still not a great way for a regulated, big institution to just go long spot Bitcoin. How many shops can hold their own Bitcoin keys? How many are really in a position to trade on Coinbase? And even if you have a way of going long the spot in size to make the trade worth it, it's not easy to get leverage to really exploit the arb in a big way.

There's a great piece by my colleague Matt Leising last month about companies like BlockFi that have been offering juicy double-digit returns to depositors in order to get USD that they can then lend to leveraged Bitcoin traders. But overall the industry is still small.

The theoretical returns to the Bitcoin basis trade are even fatter when you go off the CME to less regulated exchanges, which also have futures contracts. So for example, you can get annualized returns of 40% on the June contract at places like FTX or Binance, per Younger.

But again, how many institutions with any scale are touching these exchanges? The yields are there, but execution risks abound. In a tweet last week, the CEO of FTX Sam Bankman-Fried (a recent Odd Lots guest) explained the situation like this:

So in the meantime three things. Smaller traders/funds will probably continue to attempt to exploit the arb, but not at a big enough scale to close it. However since this is clearly getting more and more attention among institutions (hence the JPM note), larger players will probably try to find ways to take advantage. And finally as Younger notes, if there's ever an ETF approval, the spread would theoretically compress significantly, because then there would be a super simple way to go long spot and short the futures all in the same accounts -- making the execution much easier. In the meantime, keep an eye on this space. And of course this is crypto, so if anyone's feeling brave, please be careful and think about possible ways (like losing your coins) this could blow up in your face.

Joe Weisenthal is an editor at Bloomberg. 

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