Why Is Bitcoin Dropping If It’s An ‘Inflation Hedge’?
Someday, the orange coin’s fixed supply may make it a safe haven. Today is not that day. Why Is Bitcoin Dropping If It’s An ‘Inflation Hedge’?
This morning, the U.S. Bureau of Labor Statistics released updated numbers for its inflation-tracking Consumer Price Index (CPI), showing U.S. inflation has hit a 6.8% annualized rate.
That adds up to the highest year-over-year inflation rate since 1982, which is decidedly not great. Among other implications, the number is another nail in the coffin of U.S. President Joe Biden’s “Build Back Better” social spending package.
And asset markets? Wall Street had already priced in 6.7% inflation, so the Dow Jones Industrial Average has been pretty much stable as of this writing. Gold saw a modest but noticeable morning bump, while gold futures have seen a choppy but decent runup over the last six months as inflation fears gestated.
Bitcoin, meanwhile, was flat to down this morning, and down more than 25% over the past 30 days. That contradicts one of the most widely cited selling points of bitcoin – that it’s an “inflation hedge,” a place to put your money when fiat is losing real-world value.
So what gives? Why isn’t bitcoin rallying as inflation in the world’s biggest economy touches 40-year highs?
Here’s the secret that your average YouTube crypto shillfluencer will pretty much never spill: The idea that bitcoin is an inflation hedge is purely speculative. It’s compelling, and it may become true in the future, and it may be a rational reason to speculate on bitcoin right now. But it’s not a mechanism that actually functions in the present day.
It certainly seems very structurally plausible that it eventually will if bitcoin adoption continues on its current path. If enough companies, economies and individuals transfer a lot of their wealth into bitcoin, its price will become more stable, making its steady and tight issuance policy much more appealing, and reducing the risk of rotating into it when inflation is running hot.
That’s how some people use gold, which is why bitcoin is sometimes referred to as “digital gold.” Investor and CoinDesk columnist Nic Carter recently pointed out that if bitcoin were to gain adoption similar to gold, it would mean growing 10x from where we are now. That seems like a quite likely future scenario to me.
But that’s not where we are now. Currently bitcoin prices are unstable for a number of reasons that have no direct tie to inflation, and if recent price moves are any indication, those forces remain considerably more powerful than the “digital gold” narrative.
First and foremost, bitcoin has been on a nearly two-year bull run. The simple mathematics of reversion to the mean and/or the emotional gravity of profit taking made a pullback inevitable. That’s especially true because bitcoin is still quite clearly a speculative asset – its current total valuation of nearly $1 trillion (wow) is based not on current adoption, but on scenarios of future growth.
Any speculative asset is particularly vulnerable to uncertainty: Tesla stock, which is now largely a bet on Elon Musk inventing general artificial intelligence, is off roughly as much as bitcoin over the last 30 days.
That points to anxiety over the strength of the real economy, most of it focused outside the U.S. China in particular is beginning to show signs of a looming unwind, which would have serious impacts around the globe. But debt and other forms of leverage (even excluding leverage buried in stock prices) are at record levels basically everywhere.
So things are choppy and could go in a lot of different directions without much notice. A major downward shock would knock a lot of wind out of future-oriented assets, and some investors are de-risking to be on the safe side.
Relative to bitcoin’s inflation thesis, the scenario demonstrates the most inconvenient truth of economics and finance: that it’s very hard to definitively prove why nearly anything happens. There’s almost never a chance for a “controlled experiment,” a situation where only one variable changes at a time, allowing its specific impact to be fully observed.
The clearest way to really affirm bitcoin’s role as an inflation hedge would be if nearly nothing but inflation was going on, and that’s just not a situation we’re ever going to see in the real world.
Instead, on any economic or financial question, there are nearly always a large number of moving parts – including elements even professionals may be completely unaware of. Predicting the future depends on picking the right moving parts to focus on. For bitcoin, at least for now, inflation doesn’t seem to be the story the markets are listening to.
Bitcoin Jumps Past $50K As US CPI Data Shows Highest Inflation In Nearly 40 Years
CPI data is in line with forecasts but still shows a huge spike, while the long-term consequences for Bitcoin are far from universally positive.
Bitcoin (BTC) surged over $1,000 in seconds on Dec. 10 as the United States Consumer Price Index (CPI) data showed inflation in November was worse than anticipated.
November CPI Conforms To Expectations
Data from Cointelegraph Markets Pro and TradingView showed BTC/USD running to $50,132 on Bitstamp as the data became public Friday.
An hour before the Wall Street open, the pair had already hit its highest level in over 24 hours.
CPI had been hotly awaited by both crypto and traditional finance analysts alike, with opinions favoring at least a 6.7% year-on-year increase for November, and even over 7%. In the event, the numbers broadly conformed to conservative guesses, reaching 6.8%.
CPI below expectations
all markes popping
— Alex Krüger (@krugermacro) December 10, 2021
The results nonetheless mean that inflation on CPI is at its highest in almost 40 years.
Bitcoin’s short-term successes did not last long, with BTC/USD back under $50,000 at the time of writing.
The largest cryptocurrency remained trapped in a range with no visible upside bias, this requiring a break above $53,600 to change, analysts previously argued.
Yes, there’s been a decent amount of volatility for #BTC recently
In fact, $BTC has been threatening to lose this red support throughout the week but failing to confirm a breakdown
BTC has returned above red yet again
— Rekt Capital (@rektcapital) December 10, 2021
Altcoins were unmoved by the CPI event, with Ether (ETH) still down 1.3% over the past 24 hours.
Out of the top 10 cryptocurrencies by market capitalization, only Terra (LUNA) managed to eke out a small gain on the day.
Prices for bitcoin, seen by a growing number of investors as a hedge against inflation, jumped 2% after the CPI report from the U.S. Department of Labor’s Bureau of Labor Statistics.
The U.S. Labor Department’s Consumer Price Index (CPI), closely tracked by bitcoin traders due to the cryptocurrency’s use by some investors as a hedge against inflation, has risen to its highest since the early 1980s.
The CPI for all items rose 6.8% in the 12 months through November, the highest since May 1982, when it was 6.9%. The cost-of-living increase was in line with the average forecast of economists in a Reuters survey, but it marked a sharp increase from October’s 6.2% print.
Stripping away the volatile food and energy component, the CPI core reading for November was 4.9%, more than double the Federal Reserve’s stated target of 2%.
Bitcoin rose 2% in the minutes after the CPI data was released, trading around $50,000. But within the a few hours, the price had dropped to below the $48,000 level.
Crypto traders may see the high inflation rate as additional motivation for the Federal Reserve to accelerate its withdrawal of monetary stimulus. At a meeting last month, the U.S. central bank announced plans to start tapering its $120 billion-a-month of bond purchases – a form of stimulus, funded by money printing, designed to help markets and the economy heal from the impact of the coronavirus.
Next week, the Fed is expected to double the pace of the tapering to wind down the bond purchases by March, sooner than the current trajectory of mid-2022. Less monetary stimulus might be bad for bitcoin, since the cryptocurrency’s price has been buoyed in the past couple years by bets that trillions of dollars of money printing by the Fed would stoke inflation.
“We are expecting more sideways trading as eyes shift towards central bank meeting next week,” said Lennard Neo, analyst at Stack Funds.
After the release of the October CPI data, bitcoin shot up by almost $3,000 to quickly hit a new all-time high of $68,950. But within a few hours, the move reversed completely, and prices fell as more traders shifted to focus on the logical consequence of faster inflation: monetary-policy tightening by the Federal Reserve that might crimp demand for riskier assets from stocks to cryptocurrencies.
The world’s largest cryptocurrency by market capitalization is currently trading around $47,400, down 31% from the all-time high reached in early November, when the last inflation report was released. Bitcoin is still up 64% on the year.
“Today’s inflation figures were marginally less than many were fearing, but the reality is that if you’re being paid less than 7% more than you were this time last year, your purchasing power is diminishing,” said Jason Deane, crypto analyst at Quantum Economics.
He said that “The Fed has no real tools left to try and fight it and is effectively strapped into the ride with the rest of us.”
Looking ahead, Deane expects to see a rapid upward movement in gold, major indices and bitcoin.
Crypto Is An Imperfect Hedge Against Inflation
Digital currencies are an increasingly popular refuge, but how effective they are depends on what you fear the most.
I began my Wall Street career in the early 1980s, and that’s the last time I remember investors being as concerned about inflation as they are today. Back then we understood inflation had been triggered by the abandonment of the gold standard in 1971, supply-side shocks such as the 1973 oil embargo, misguided monetary policy and perverse government policies like controls on interest rates, wages and prices.
The message for investors was clear: abandon stocks and bonds for gold and hard assets like real estate, invest in countries with stronger currencies like Switzerland, Japan and Germany, and don’t trust financial institutions.
Current inflation fears are different, and many investors doubt that the hedges from the 1970s are still reliable.
Cryptocurrencies are an increasingly popular refuge for inflation-phobic investors, both the “digital gold” of Bitcoin and newer crypto assets designed not just to be inflation-proof, but to capitalize on rising prices. How attractive these new instruments are depends on what kind of inflation you fear.
Supply-chain disruptions are certainly contributing to higher prices, but many people believe they are transient. If that’s not true, and if elevated infectious disease rates and cultural changes resulting from the pandemic have permanently reduced economic efficiency and the willingness to work among a large group of the population, there will be fewer goods and services available.
If governments respond with stimulus spending, subsidies and deficits—increasing the supply of money and transferring wealth from private sector workers to government workers, retired people and the unemployed—it could fuel inflationary spirals.
If this is your fear, then the biggest problem is slow economic growth, not inflation. Crypto might give some protection against inflated money supply, but it doesn’t create more goods and services. Many crypto ideas are technology start-ups implemented as decentralized autonomous organizations rather than traditional corporations. Start-ups thrive in growing economies, not stagnant ones.
There are crypto ideas dedicated to improving or bypassing supply chains, and others that offer the types of employment some post-lockdown workers may prefer. These could be good venture capital investments, but they’re far too risky to be considered inflation hedges. Supply chain issues are global, and could be driving inflation in China, the euro zone and emerging markets, all of which are elevated.
Another global threat to the value of currencies is international tension. Nothing causes inflation like war and there are simmering conflicts around the globe, some that could lead to shooting wars and cooler ones driving sanctions, financial barriers and tariffs.
Crypto’s advantages over traditional finance soar in wartime and financial conflict. The best bets for this scenario are the most established coins — Bitcoin and Ethereum — with large holders in all countries, plus crypto with strong privacy protections, such as Monero and Dash. (I invest in crypto and also use coins for transaction purposes. I don’t own any of the four coins mentioned, but may purchase them in the future.)
The main focus of most U.S. investors is on U.S.-centric inflation fears, namely rising government budget deficits and loose monetary policy. Democrats want large spending increases on top of already huge deficits and large debt. While the party favors tax increases in principle, proposed legislation includes more tax cuts and credits than tax increases.
Moreover, some of the ways to pay for spending in the Build Back Better legislation is through price controls on prescription drugs rather than actual tax increases. Legislating low prices fuels inflation rather than fights it, especially when it counts a tax increase for budget purposes.
If Republicans gain power in the midterm elections, things are still worrisome for inflation. While Democrats are enthusiastic spenders and half-hearted about raising taxes, Republicans are enthusiastic tax cutters and half-hearted about reducing spending. When the two parties get together on bipartisan legislation, we often get the least fiscal responsibility.
And when “drunken sailors” in Congress combine with politicized central bankers who seem more interested in denying or excusing inflation than fighting it, there is the potential for a virulent, persistent inflation to emerge, immune to standard fiscal and monetary measures.
This may lead to nothing less than an economy-killing general loss of confidence in the dollar, as we saw in the 1970s. It also threatens financial institutions and contributes to political dysfunction.
But it’s important to keep in mind this hasn’t happened yet. The breakeven inflation rate on 10-year Treasuries is 2.5% per year, suggesting the market thinks future inflation is likely to be at the levels considered normal before the 2008 financial crisis.
While recent inflation rates have been high, the average annual rate since 2006 has only been 2.2%. Yields on Treasuries securities remain very low. Prices in some key areas, including energy, seem to have peaked and may be declining.
If U.S.-dollar inflation is your concern, you have the simple option of moving investments to countries and currencies with better fiscal and monetary management. Crypto can be considered one such country, and in fact this scenario was the main motivation for the creation of Bitcoin back in 2008.
Overall, I think anyone seriously worried about inflation should put crypto on the table as an option that can protect against some inflation scenarios and take advantage of others. It’s not a magical hedge against inflation. Nearly all crypto assets have so much non-inflation-related risk that they are appropriate only as small parts of diversified portfolios rather than either core holdings or pure hedges.
Bitcoin Isn’t An Inflation Hedge Yet, But Here’s How It Could Be
The bitcoin inflation hedge thesis is being put to the test and so far it’s not faring well, says our columnist.
Last week, inflation data for the month of January was reported for the United States: The U.S. dollar lost 7.5% of its purchasing power compared to one year earlier, the biggest drop in 40 years. While this is not a good situation for the U.S. economy, one might have predicted this would be a moment of vindication for bitcoin holders. But it’s not panning out that way.
Since inflation really started to tick up in the spring of 2021, bitcoin has lost 18% of its value relative to the dollar, underperforming other risk assets like the S&P 500 stock index (up 8%) and traditional inflation hedges like gold (up 7%). Both bitcoin and the Standard & Poor’s 500 stock index are down 8% so far in 2022, while gold has rallied 3%.
Bitcoin, despite its fixed supply and the popular “store of value” thesis, continues to trade with high volatility and tighter correlation with relatively risky assets like stocks versus traditional safe havens like gold. It is not inflation per se driving this price action, though. It is the U.S. Federal Reserve’s signaled response to inflation: hiking interest rates over the course of this year to mop up some of the excess liquidity in the economy, strengthen the dollar once more, and get inflation under control.
The market’s movements and the backdrop of interest rate increases is reminiscent of the last quarter of 2018, the last time the Federal Reserve went through a hiking cycle. Over that period, bitcoin (as well as the crypto market as a whole) lost 40% of its value, while the S&P 500 retraced its gains on the year and dropped 14%.
The manic highs of the prior year, 2017, were at least partially attributable to the amount of easy money that the Federal Reserve and other central banks globally had pumped into the economy. Risk assets as a whole, from high-beta tech stocks to emerging markets debt, were beneficiaries of all this liquidity – and bitcoin and the rest of the nascent crypto industry had caught that same bid.
I wrote at the time about the wild investments that people were making in the economic context of too much money sloshing around: All the way out on the risk spectrum were tokens associated with “[initial coin offerings] into which investors [had] dumped an estimated $20 billion … often with little in the way of investor rights or protections.”
I cannot help but think that number sounds quaint now, both in the context of the valuations that many of those ICO-related projects have ballooned into and also in the context of investors in 2021 and the first month of 2022 having traded more than $30 billion in JPEGs. Some of this volume is of course wash-trading, and of course I am aware these are not actually “just JPEGs.” But still, talk about “risk on.”
The mania of the last couple of years far outstripped what we saw during the 2017 hype cycle. The increase in dollars that have been printed into existence has been absolutely unprecedented since the global coronavirus pandemic took hold: Annual growth of the money supply, which ranged from 3%-7% between 2015 and 2020, spiked to 20-30% in the months following March 2020.
The mania was predictable, the inflation was predictable and now the rate hikes and the drawdowns on risk assets (including bitcoin) are predictable, too. If 2018 is anything to go on, we could be looking at declines in asset values that double (or more) from here.
The magnitude and duration of the declines are hard to foresee and will be dependent on whether the Federal Reserve can guide the economy to a soft landing from its current state, flying too close to the sun.
With bitcoin as of yet failing to fulfill its promise of serving as an inflation hedge, it is worth reflecting on what needs to happen in order for it to start trading as such.
How Bitcoin Becomes A Genuine Store-Of-Value
Perhaps the most foundational shift that needs to occur in order for bitcoin to behave as a store of value is the market needs to mature. A mature market is characterized by long-term investors who can afford to weather volatility and price drops – and can even take the other side of these trades, lending support and stability to the asset.
Often these investors are institutional investors, but I would argue they do not necessarily need to be big traditional banks and asset managers, though those would not hurt. More and more crypto-dedicated funds are in position to be able to serve as these stabilizing forces in the market.
Another hallmark of market maturity is the development of common frameworks, metrics and classifications used across market participants. There are certain heuristics that investors and traders develop over time to rapidly understand, consider, and trade assets. Even the notion of a risk spectrum is an example of this.
With risky tech stocks and emerging market assets at one end and with gold and U.S. Treasury bonds as the safe-haven assets at the other end. Investors and traders share an understanding of asset class categorizations and how those categories are broadly expected to trade in various market conditions. There is a recursiveness to the market. Investors expect gold to go higher when inflation ticks up, and so it does!
Today, crypto assets are not yet disambiguated with any sophistication by market participants. In the context of macro markets, bitcoin, ether, ADA, SOL and AVAX are all lumped together. For traders and investors who spend all day on crypto, this is of course not the case, but just watch the next time any mainstream financial news outlet covers crypto.
Only rarely are these and other tokens broken out as different categories or classes. For bitcoin to stop trading like a risk asset and start trading as an inflation hedge, it needs to be viewed as a separate asset class from the rest of the crypto markets.
There are signs this is starting to happen, with the likes of Goldman Sachs publishing research separating bitcoin from the others and deeming it a “store of value” to compete with gold.
Of course, it will take more than narrative and a few research notes to get there. As the crypto market matures toward mainstream finance, the large investors and traders will need to align not only on classifications but also on the parameters that determine those categories, enabling a more nuanced perspective on bitcoin as well as other crypto assets.
Just as stocks have price-to-earnings and other ratios the markets have coalesced around in order to evaluate them and commodities have their specific supply and demand dynamics, so, too, should the market align on common metrics that matter when it comes to the various categories of crypto assets.
Some of these metrics have already emerged and just need to be more widely adopted and viewed as a signal in the context of macro markets.
Some examples of these benchmarks include: inflation rate of the crypto asset; eventual fixed supply (in the case of bitcoin); implied 2030 market cap; and “coin days destroyed” or the number of days a given asset has been dormant in a wallet. These standards exist. They just have not become salient enough and pervasive enough amongst all the major market participants.
That there is no clear standard view or categorization for bitcoin is well demonstrated by Goldman itself. Only six months prior to its latest piece on bitcoin as a store of value, it put out a note stating: “We view gold as a defensive inflation hedge and crypto as a risk-on inflation hedge,” failing to call out bitcoin as a possible exception.
The big bitcoin inflation hedge thesis is finally being put to the test in the United States, and it is not faring well so far. As the crypto markets continue to mature and as market participants begin to differentiate bitcoin from the multitude of other crypto assets out there, there is reason to believe that it can still fulfill its promise as a store of value.
Market maturity, common valuation frameworks and shared narratives take time to develop, however, so you might not want to put all of your money on bitcoin to hedge the devaluing U.S. dollar just yet.
Fed Needs To Spark A Market Crash To Bring Down Inflation (#GotBitcoin)
Three (3) Themes Have Emerged:
While mortgage rates have moved up recently, overall financial conditions remain roughly where they were in the summer of 2020, just after the central bank flooded the system with emergency liquidity.
The first is the Federal Reserve’s struggle to tighten financial conditions even as it prepares to raise interest rates. While mortgage rates have moved up recently, overall financial conditions remain roughly where they were in the summer of 2020, just after the central bank flooded the system with emergency liquidity.
Another theme has been the idea of a wealth effect from booming stocks, houses prices and potentially crypto. And while wealth effects are something every economist thinks about, the degree to which higher asset prices might be fanning inflation is perhaps still unappreciated.
Joseph Wang, a.k.a “Fed Guy,” called the latter a potentially “enormous wealth boom that you don’t see,” and one that might even be contributing to current tightness in the labor market.
The third theme is the idea that the Fed may have to induce a recession in order to bring down inflation. After all, it can’t do much to boost supply. It can only bring down inflation by curbing demand, in which case it will need to slow growth in order to ease pricing pressures. That’s something which has been brought up by Citigroup Inc. Strategist Matt King as well as the SGH Macro’s Tim Duy.
Only one man can marry these three themes together, of course, and that is Credit Suisse Group AG Strategist and repeated Odd Lots guest Zoltan Pozsar.
In a note published late on Wednesday, Pozsar argues that in order to tame inflation, the Fed needs to mount a Paul Volcker-style shock strategy aimed at popping valuations in risk assets that range from stocks to credit and even crypto.
And while that’s a pretty controversial idea on Wall Street, Pozsar’s argument is that tightening financial conditions in this manner would allow the Fed to slow services inflation (including owner’s equivalent rent, or OER) without completely derailing growth.
The idea here is that given that if the Fed needs to balance two slightly altered mandates — stable prices and inclusive employment — it might make more sense to do that by bringing down asset prices rather than tank the entire economy in a way that will hit low-income households hardest:
“Just as your correspondent is not an expert on inflation, neither is he an expert on labor matters, but growing up in Hungary, his common sense whispers that if the post -Communist government response of generous transfer payments and early retirement sapped labor force participation and hurt the real growth prospects of Hungary and other economies, the capitalist market response to low interest rates and QE through sky -high equity valuations, house prices, and the rise of Bitcoin probably does the same:
if the young feeling Bitcoin -rich are less inclined to work and the old feeling mass affluent are eager to retire early, labor force participation drops to the detriment of real growth prospects.
If early retirement wasn’t good for Hungary, it won’t be good for the U.S. either … Maybe the path to slower services inflation – OER and all other services – is through lower asset prices. We recognize that what we are saying is extreme, but we think the Fed will soon incorporate some version of this thought process.
It wasn’t tried before, but what was tried before, the Fed cannot do anymore due to the political imperatives of inclusive low unemployment and redistribution. Hence the need for a Volcker moment.
Volatility is the best policeman of risk appetite and risk assets. To improve labor supply, the Fed might try to put volatility in its service to engineer a correction in house prices and risk assets – equities, credit, and Bitcoin too… Legendary central bankers like Paul Volcker or Mario Draghi either sparked or tamed volatility: Draghi tamed volatility with his bumblebee -themed speech, and Volcker sparked volatility by starting to target quantities instead of rates, and he didn’t talk too much about what he was doing – he kept the market guessing.
Maybe the Fed should hike 50 bps in March, put an end to press conferences, and sell $50 billion of 10 -year notes the next day… Maybe FOMC members talk too much. They don’t keep the market guessing. They suppress volatility… A new Volcker moment should also mean a radical change in the Fed’s strategy and involve going from targeting rates to targeting quantities once again – not the quantity of reserves in the banking system, but the quantity of duration in the market -based shadow banking system to jolt all sorts of risk premia higher.
No, lower risk assets won’t kill growth. This is not a balance sheet recovery, and no, higher mortgage rates won’t kill growth either – wage growth at 5% can absorb higher monthly payments. The curve is flat and borderline inverted, and delivering slope into it can come from higher term premia engineered by the Fed, not only rate cuts as the ‘policy -mistake -in -the -making’ crowd would have it…
The Volcker moment is the eight h channel of QT (from passive to active QT), and today’s Dispatch is the eleventh in a series exploring QT, and an eleventh hour appeal to market participants to start thinking about QT in a macro (active vs. passive), not just a micro (beautiful, ugly, or whiplash) sense… The decisions of central bankers are always redistributive.
For decades, redistribution went from labor to capital. Maybe it’s time to go the other way next. What to curb ? Wage growth? Or stock prices? What would Paul Volcker do?”
Of course, threading the needle between popping lofty asset prices without causing a massive crunch in credit that feeds into the broader economy can be tough. But then again, it feels like there are only tough choices facing the Fed right now.
If Bitcoin Benefited From Quantitative Easing, Will It Be Hurt By Quantitative Tightening?
An uptick in Bitcoin (BTC) supply to whales’ addresses witnessed across January appears to be stalling midway as the price continues its intraday correction toward $42,000, the latest data from CoinMetrics shows.
Whales, fishes take a break from Bitcoin
The sum of Bitcoin being held in addresses whose balance was at least 1,000 BTC came to be 8.10 million BTC as of Feb. 16, almost 0.12% higher month-to-date. In comparison, the balance was 7.91 million BTC at the beginning of this year, up 2.4% year-to-date.
Notably, the accumulation behavior among Bitcoin’s richest wallets started slowing down after BTC closed above $40,000 in early February. Their supply fluctuated within the 8.09–8.10 million BTC range as Bitcoin did the same between $41,000 and $45,500, signaling that demand from whales has been subsiding inside the said trading area.
A similar outlook appeared in addresses that hold less than 1 BTC, also called “fishes,” showcasing that they had halted the accumulation of Bitcoin in February as its price entered the $41,000–$45,500 price range.
Looks like the accumulation trend is stalling with #BTC around $44k:
No breakout for the whales addresses.
Plateau for the small fish.
I guess everyone is cautious while waiting to see what the FOMC will do next. pic.twitter.com/Ou8w1t7U5m
— ecoinometrics (@ecoinometrics) February 17, 2022
Ecoinometrics’ analyst Nick blamed the Federal Reserve’s aggressive tightening plans for making Bitcoin whales and fishes “cautious,” reiterating his statements from last week, wherein he warned that “if Bitcoin has greatly benefited from quantitative easing, it can also be hurt by quantitative tightening.”
“This is why inflation not showing any sign of slowing down is a big deal.”
No “dot plot” Yet
On Feb. 16, the Federal Open Market Committee released the minutes of its January meeting, revealing a group of thoroughly alarmed central bank governors looking more prepared to hike rates too much to contain inflation.
As for how fast and how far the rate hikes would go, the minutes did not leave any hints.
Vasja Zupan, president of Dubai-based Matrix Exchange, told Cointelegraph that the Fed fund futures market now sees a 50% possibility of a 50bps rate hike in March, a drop from the previous 63%. But the minutes, themselves, do not discuss a 0.5% interest rate increase anywhere.
“Of course, the mixed macroeconomic outlook has left Bitcoin’s most influential investors — the whales and long-term holders — in the dark,” asserted Zupan, adding:
“The top cryptocurrency has been cluelessly tailing day-to-day trends in the U.S. stock market. However, I see it as weighted and not long-term significant, especially as the Fed bosses—hopefully—shed more light on their dot-plot after the March hike.”
Strong Hodling Sentiment
Researcher Willy Woo provided a long-term bullish outlook for Bitcoin, noting that its recent price declines, including the 50% drawdown from $69,000, were due to selling in the futures market, not on-chain investors.
“In the old regime of a bearish phase (see May 2021), investors would simply sell their BTC into cash,” Woo wrote in a note published Feb. 15, adding:
“In the new regime, assuming the investor wants to stay in cash rather than to rotate capital into another asset like equities, it’s much more profitable to hold onto BTC while shorting the futures market.”
As Glassnode further noted, in the May–July 2021 session, investors’ de-risking in the Bitcoin futures market coincided with a sale of coins in the spot market, which was confirmed by a rise in net coin inflow to exchanges. But that is not the case in the ongoing price decline.
“This trend of net outflows has now been sustained for around 3-weeks, supporting the current price bounce from the recent $33.5K lows.”
U.S. Treasury’s Golden Fed Goose Is About To Get Cooked
Quantitative easing generated ample income for the government. That’s about to change.
The U.S. Federal Reserve’s vast securities-purchasing program has had an ancillary benefit beyond stimulating economic growth: It has generated profits for the Treasury, as the income on the securities has exceeded the interest the central bank pays on its liabilities.
Now, though, those profits are set to diminish, and even turn into losses, as the Fed raises short-term interest rates. Technically, this shouldn’t be a problem. Politically, it could be.
The asset side of the Fed’s balance sheet consists of some $8.8 trillion in Treasury and agency mortgage-backed securities returning an average of about 1.5% a year.
The liability side has multiple components: currency outstanding, which entails no interest payments and comprises about a quarter of all assets; the Treasury’s account, which fluctuates along with budgetary income and spending; and bank reserves and other short-term borrowings, on which the Fed pays interest that varies with the federal funds rate.
In 2021, the income on the assets exceeded the interest on the liabilities by a record $107.4 billion. But that will change as the Fed raises its target rate toward or even beyond a neutral level, which officials estimate to be 2.5%.
The size and speed of the profit decline will depend on many variables, including the pace of monetary tightening and balance-sheet shrinkage, the yield the Fed earns on reinvested assets, and how much currency outstanding grows over time. But there are reasons to expect it to be much larger and sharper than during the last economic cycle.
High inflation is pressuring the Fed to raise short-term rates more and faster; the balance sheet will still be very large when short-term rates are much higher; currency comprises a smaller share of the larger balance sheet; low longer-term yields mean a lower average return on the Fed’s assets.
If short-term rates rise to the Fed’s assessment of neutral in 2023, this might be sufficient to generate losses. And if the Fed has to tighten like it did from 2004 to 2006, net interest earnings would turn sharply negative.
In principle, this needn’t be a big problem. No doubt, the collapse in Fed reimbursements to the Treasury will add to the federal government’s debt service costs, adding to the effects of increasing debt and interest rates.
Beyond that, though, losses won’t impede the Fed’s ability to operate effectively. This is true even if they deplete the Fed’s capital: Central banks, unlike commercial banks, don’t need positive capital.
Moreover, the Fed has already designed a fix to avoid even the perception of a capital shortfall: Create a deferred asset from the Treasury to equal the losses, to be repaid from future net interest income — recognizing that the squeeze on income will likely diminish as the balance sheet continues to shrink and currency outstanding increases over time.
In practice, losses at the Fed will almost certainly invite greater scrutiny, particularly of the asset-purchase program. Critics will argue that the central bank’s actions have drifted over the line into fiscal policy, and attempt to constrain its use of its balance sheet. This, in turn, could impair the Fed’s ability to fight the next recession.
So what should the Fed do? Avoiding losses by refraining from rate increases would conflict with its responsibility to keep inflation in check.
Reducing the balance sheet faster, and hence increasing the share of interest-free currency on the liability side, is fraught for many reasons — not least that selling off assets in a higher-interest-rate environment would generate even more losses.
This leaves the Fed with one good argument: Its net interest earnings should be evaluated over the course of the business cycle, not in a single year.
The Fed’s cumulative earnings over the past 14 years are much greater than they would have been if the central bank hadn’t expanded its balance sheet, and any losses should be viewed in that context. I expect officials to make this case — but how much it will mollify the Fed’s critics remains to be seen.