key takeaways
- Crypto surges to start the year on the back of expectations of an earlier-than-expected interest rate cut
- This contradicts the view that crypto is uncorrelated, it turns out to be wrong
- Assessing crypto’s price action through the pandemic and subsequent rate-hike cycle shows an extremely risky asset class that moves in line with other speculative asset classes
In the past few months, markets have turned green on the back softening of inflation data All over the world. Crypto is not left off the invite list, with digital assets being the strongest rally in nine months,
If there ever was any doubt (and by now, there really shouldn’t be), this proves once and for all that any narrative about crypto is an uncorrelated asset.
pandemic bull run
To quickly recapture the past few years in cryptoland, the asset class initially rocketed violently upward as central banks around the world adopted ultra-low interest rate policy.
As economies ground to a halt for the ultimate black swan, the COVID-19 pandemic, nations faced a highly uncertain outlook for the first quarter of 2020. With the world on lockdown, central banks were forced to do what they could to encourage these sudden-shutdowns. Society.
A stimulus package of unprecedented scale arrived.
With all this stimulus and generationally cheap money, risk assets have gone bananas. The biggest leader of all was cryptocurrency. Some argued that the asset was rising as a result of the inevitable inflation that would result from all this expansionary monetary policy, as crypto was a hedge against the fiat system. There will be no argument.
Transition to a New Interest Rate Paradigm
The year 2022 actually brought a rise in inflation, and this time central banks were forced to do the opposite – aggressively raising rates as the cost of living rose steadily.
It has reined in risk assets as per the playbook. Liquidity is sucked out of the system, suppressing demand. Investors now have alternative vehicles in which to park their assets and earn a yield, with government-guaranteed T-bills now providing a reasonable alternative, as opposed to zero rates (or negative in some countries) earlier. .
But the cryptocurrency followed the rest of the world’s risk assets. Not only that, but the scale of the downturn in this sector was unlike anything we’ve seen in a major asset class in a long time. Bitcoin It shaved off more than three-quarters of its market cap, and it compared favorably to altcoins, many of which were destroyed.
And now, the past few months have brought more optimistic readings on inflation. The numbers are still scary, but there’s just a little bit of positivity that the worst has passed. Of course, there’s still a war going on in Europe and now fears have grown that a recession may be imminent (if it isn’t already here), but hey – let’s celebrate what we can win.
The stock market has moved cautiously higher, as the market moves towards the expectation that high interest rates will end sooner than previously expected.
Only thing is, crypto has also grown. Not only this, but it has printed profits which blow the moves in equity markets out of the water.
Which, you know, kind of suggests that this may not be an inflation hedge. As inflation returns and the prospect of lower rates and another expansionary period increases, crypto rises. go figure.
Correlation versus the stock market remains high
The proof is in the pudding. Looking at the price chart of the S&P 500 versus bitcoin it is very clear that the correlation here is stark – with the key secret variable being interest rates.
In fact, crypto is the opposite of an uncorrelated asset – it has moved in lockstep with the stock market for the past few years.
Interestingly, however, there have also been periods of separation. Unfortunately, they have come amid a crypto-specific crash. To show this, I plotted the bitcoin/S&P 500 correlation against the price of bitcoin over the past few years.
The correlation has been high, except for a few noticeable periods – all of which occurred when the price of bitcoin fell. The most recent example was in November 2022, when the cryptocurrency faltered between ftx crash,
There’s really no debate here. Crypto is a highly correlated, highly risky asset. The only question is whether it can shed this moniker in the long term. But countering any idea that it isn’t currently wildly speculative is bigger than the mark.