Recent market views on the Federal Reserve’s December rate path have diverged sharply. Earlier, mild inflation and weak labor data led many to believe another December rate cut was nearly certain. However, the Fed’s recent hawkish rhetoric has dampened this optimism. Despite dovish signals from officials on Friday, debates over year-end monetary policy remain unresolved.

Michael Hartnett, Chief Investment Strategist at Bank of America, stated in his latest "Flow Show" report that the Fed faces mounting pressure to continue cutting rates due to liquidity tightening across multiple asset classes. Cryptocurrencies, he argues, will be the first to detect a central bank policy shift.

Hartnett noted that assets like cryptocurrencies, credit, the U.S. dollar, and private equity have all shown signs of "peak liquidity." Over the past two years, global central banks’ 316 rate cuts fueled speculative fervor, but recent Fed hawkishness has cast doubt on further easing in 2026. Cryptocurrencies have been hit hard, with Bitcoin and Ethereum plunging, highlighting liquidity tightening’s impact on risk assets.

Hartnett expects current weakness in U.S. bank stocks—echoing signals from December 2018—to pressure the Fed into easing. In 2025, global rate cuts spurred a liquidity boom, driving AI investment mania, Japanese stock volatility, and crypto speculation.

Looking ahead to 2026, Hartnett predicts the Fed will "capitulate" and restart rate cuts. Three assets stand to benefit most: 1. **Long-duration zero-coupon bonds**, which gain directly from falling rates. 2. **Bitcoin**, historically the first to rally on liquidity signals before full policy shifts. 3. **Mid-cap stocks**, highly sensitive to financing costs, poised for earnings recovery and catch-up gains.

**Japan’s Debt Crisis Fuels Global Liquidity Fears** Japan faces simultaneous bond and yen collapses. The 30-year JGB has fallen 5% in two weeks, down 12% YTD—its worst performance since the 1970s. The yen nears 160 against the dollar, a 40-year low.

Policy misalignment exacerbates the crisis: Japan’s new Prime Minister unveiled fiscal stimulus worth 3% of GDP, while the BoJ’s real policy rate remains -2%. This "loose fiscal + loose monetary" mix worsens yen depreciation and bond selloffs.

With JGB yields breaking key resistance—contrasting global bond rebounds—policymakers face a dilemma: hiking to curb inflation risks stock crashes, while maintaining easing pressures the yen and bonds. The crisis spreads globally via unwinding carry trades, potentially triggering capital flight from U.S. assets.

**Liquidity Tightening Signals Mount, Fed Pivot Nears** U.S. mid-caps show stark valuation-performance divergence. Despite low 15x P/E ratios and benefits from trade détente and reshoring, they remain under pressure—a sign the Fed’s policy lags market needs.

Bank and broker indices, highly sensitive to liquidity, have broken key levels (140 and 950, respectively). Like in December 2018, they may lead the next easing cycle.

Hartnett sees clear signals for more Fed cuts. Past easing fueled "collective euphoria," but recent hawkishness stirs doubts. When the Fed pivots, risk assets will rebound sharply.

**Cryptos as Policy Canaries** Hartnett calls Bitcoin a "canary in the coal mine" for central bank shifts, given cryptos’ liquidity sensitivity. Despite recent crashes, he expects cryptos to front-run Fed rescues.

BofA’s November survey shows institutional crypto allocations at just 0.4%, but 2025 retail inflows hit a record $46B. Derivatives now make up 74% of crypto volumes, making it a liquidity and speculation hotspot. Retail enthusiasm signals strong easing expectations. Once the Fed turns, cryptos may lead the rebound.