With the recent CPI data from the United States, it would be easy to believe that the US Federal Reserve (FED) will be increasingly hawkish on interest rates, which in turn would be likely to weigh on Bitcoin prices (as they have become increasingly interest rate sensitive). However, due to the oil price and associated threat of recession, we believe the FED has limited firepower to raise interest rates. Furthermore, we believe interest rate expectations are already factored into the current Bitcoin price.
The Luna and UST stablecoin crisis has piled further pressure on digital assets. While the value wiped out from the Terra ecosystem was substantial (over $40bn), it was not systemic to the wider crypto space, as it represented less than 2% of the stablecoin market.
Bitcoin now has a well-established inverse correlation to the US dollar. This makes sense due to its emerging store of value characteristics, but it also makes it incredibly sensitive to interest rates. The price declines over the last 6 months can, by and large, be explained as a direct result of increasingly hawkish rhetoric from the FED. The Federal Open Markets Committee (FOMC) statements are a good indicator of this, and we can observe a clear connection to statement release times and price moves.
Bitcoin’s correlation to gold has declined while it has risen significantly when correlated against equities, particularly interest rate-sensitive equities such as growth stocks. In some ways this is a correct interpretation by the market, non-yielding assets will suffer during rate hikes.
But let’s not let that lead us to think of bitcoin just as a growth asset. It is both a growth asset and an emerging store of value, as defined by its predictable and finite supply, its correlation to equities is therefore likely to decline.
The biggest challenge for Bitcoin investors is to determine how sustained the US Dollar strength will be. One could argue that much of the market expectations on US interest rate hikes have now been fully priced in. Some economic data is beginning to roll over, such as wage growth and purchasing manager indices but perhaps the most worrying indicator is the impact oil prices are having on the US and the global economy.
Historically, sharp rises in oil demand have almost always been followed by economic recessions in the United States. They have typically been prompted by major oil crises such as Yom Kippur in 1973, the Iranian Revolution in 1978–79, the first Iraq War in 1990 and 911 in 2001.
The FED’s prior intransigence to inflation is now being born-out in a much more aggressive knee-jerk approach. This is happening at an unfortunate time as the federal debt growth from 30% of GDP to over 100% today has severely reduced the policy flexibility it enjoyed to combat inflation in the 1980s. Producer prices in the US are now at the highest levels seen since 1975, and as this trickles down to the broader economy, either in the form of tighter corporate earnings or rising costs of goods, it will be a significant impediment to growth.
The FED has a fine needle to thread, engineering a soft landing for economic growth while taming inflation. This is particularly challenging as many involved factors are out of their control, such as the Ukraine war and its influences on oil prices and Covid-related supply chain issues. Inflation can probably be tamed, but at what price? History suggests the price will be an economic recession.
While we believe we are likely to see the US Federal Reserve continue to hike rates through the summer, we also believe they are likely to adopt a softer outlook on economic growth thereafter, prompting considerable dollar weakness.
While Bitcoin’s price performance has been weak in the face of an aggressive FED, this current hiatus in price-performance may very well be short-lived. We believe a policy mistake is highly likely, where Bitcoin prices are likely to diverge from growth equities, with the former likely to benefit from a dovish FED and weaker USD, while the latter underperforming in the face of a recession or stagflation.
Sadly, we believe that the US and the rest of the world are likely to slip into economic decline in 2023, although there are many unknowns. Perhaps it will be stagflation which then progresses into recession? As the liquidity trap really takes grip on central bankers, we believe Bitcoin is a good insurance policy in the face of this monetary policy mess.