FTX and the banana bend in the markets

Here we are again at two of the market themes that have cropped up again and again this year: the chaotic game of catastrophe in crypto and the hunt for a more lenient stance from the Federal Reserve.

Both are dramatic in their own way, but the latter is much more important to the health of mainstream investors' portfolios.

The glee that comes when crypto takes a tumble is always tempered by the grim knowledge that some naive amateur investors are losing their savings. Bitcoin, the largest token of the bunch, has fallen by around 18 percent over the course of the week.

But all the new buyers who came in after that, down 70 percent from November to June and stuck at about $20,000 apiece after that, probably knew what they were getting into. If you were holding on after the crash, you probably knew it was a barge.

Small investors are primarily harmed by the floating value of the coins. The professionals take the pain away through their stock investments. And they suffered a brutal collision with reality this week after Sam Bankman-Fried's FTX - supposedly the more reliable exchange in this freewheeling market - suffered a good old-fashioned bank run before declaring bankruptcy.

First, confidence evaporated from FTX's native token, FTT - a fairly common occurrence with tokens built on trust and hand-waving ambition rather than traditional boring things like revenue, dividends, interest payments and institutional resilience.

That was bad enough, but FTX rival Binance came in and made things worse. First by publicly declaring its intention to sell its holdings of FTX tokens, and then by offering to bail out the exchange itself before it pulls out of such a deal, leaving its chief executive Changpeng Zhao as the last remaining king of crypto. SBF, as he is known, had to resign as chairman.

This is all high-class drama and humiliating for FTX's backers, who certainly drank the Kool-Aid. One of them, venture capital firm Sequoia, said this week that it will write down its $210 million investment in FTX to zero, noting that “a liquidity crisis has created solvency risk for the exchange.”

Compare that to Sequoia's effusive assessment of FTX's prospects in an extremely long article it published online less than two months ago. In a now-deleted 13,800-word profile (that's about 16 times the length of this column), Sequoia described Bankman-Fried's "legend status." His explanation of how you could one day “buy a banana” with FTX (I’m not kidding) got the Sequoia team excited. “I love this founder,” one said. “It was a vision about the future of money itself,” the profile explained. Now you will have difficulty withdrawing your funds from FTX, let alone buying fruit with them.

The best comedy or drama screenwriters in the world couldn't come up with a more ridiculous unraveling of an industry that has long been on the brink of absurdity. Remember that just last year Bankman-Fried himself told the FT that he would very much like to buy Goldman Sachs. And yet the coins still stick. Even with all these slings and arrows, Bitcoin is trading at around $16500. Morgan Stanley expects many won't sell until we get down to $10,000, based on when retail investors got in and trading psychology.

In fact, the price of the token briefly rebounded from its lows this week after a break in the inflation clouds finally formed.

Data released Thursday showed annual U.S. inflation was 7.7 percent in October. By any reasonable standard, this is extremely high and well above target. But it marked the smallest 12-month increase since January.

All year long, investors have been desperately looking for a sign that the Fed might at least slow the pace of rate hikes, and they finally found one, in cold, hard data.

The market reaction was absolutely explosive. The S&P 500 index gained 5.5 percent. If you strip out the wildly volatile scenes in spring 2020, this is the biggest daily rally in more than a decade and one of the biggest of all time. The tech-heavy Nasdaq Composite closed 7.4 percent higher.

Government bond prices shot up, putting pressure on yields. The yield on the two-year note fell around 0.25 percentage points to 4.33 percent, the sharpest decline since October 2008.

This is what the market says: Mission accomplished. Crisis over. Are investors getting ahead of themselves? Yes. This is just a data point and is not guaranteed to push the end point of the Fed's rate hikes lower. But that's how the game works. And fund managers have held more cash than ever since 2001, according to Bank of America data, providing enormous leverage for the recovery.

“The markets finally got what they wanted,” said Emmanuel Cau, a strategist at Barclays. The reaction was “euphoric” and increased FOMO – the fear of missing out, he says.

The fact that this even seems to have given Bitcoin a boost after a week in which it became apparent that the market's foundations were built on sand tells you two things: First, after a few false starts, this could be the big one this time, the start of a significant market recovery after a terrible 12 months. Second, you can't buy bananas on the blockchain, and you probably never will.

katie.martin@ft.com