Key Takeaways

Crypto has risen to start the year off the back of expectations that interest rates may be cut sooner than anticipated
This contrasts with the view that crypto is uncorrelated, proving it false
Assessing the price action of crypto through the pandemic and subsequent rate-raising cycle shows an extremely risky asset class that moves in line with other speculative asset classes

Over the last couple of months, markets have turned green off the back of inflation data softening around the globe. Crypto hasn’t been left off the invite list, with digital assets surging to their strongest rally in 9 months.

If there was ever any doubt (and by now, there really shouldn’t be), this proves once and for all that any narrative around crypto being an uncorrelated asset is dead.

Pandemic bull run

To quickly recap on the last few years in cryptoland, the asset class initially moved violently upward as central banks worldwide pursued 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 in Q1 of 2020. With lockdowns sweeping the world, central banks were forced to do what they could to stimulate these abruptly-shut societies. 

Out came stimulus packages of an unprecedented scale. 

With all this stimulus and generationally cheap money, risk assets went bananas. The biggest leader of all was cryptocurrency. Some argued that the assets were 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. The argument wouldn’t hold.

The transition to a new interest rate paradigm

The year 2022 did indeed bring a spike in inflation, and this time central banks were forced to do the opposite – aggressively hike rates as the cost of living spiralled relentlessly.

This has reined in risk assets, as per the playbook. Liquidity is sucked out of the system, suppressing demand. Investors now have alternate vehicles in which to park their wealth and earn a yield, with government-guaranteed T-bills now offering reasonable alternatives, as opposed to the zero rates previously (or negative in some nations).

But cryptocurrency followed the rest of the world’s risk assets down. Not only that, but the scale of the meltdown in the sector was unlike anything we have seen in a major asset class in a long time. Bitcoin shaved over three-quarters of its market cap, and it came out favourably compared to altcoins, many of which were decimated.

And now, the last couple of months have brought more optimistic readings regarding inflation. The numbers are still scary, but just a little bit of positivity has crept in that the worst may have passed. Of course, there is still a war ongoing in Europe and now fear has elevated that a recession may be imminent (if not here already), but hey – let’s celebrate whatever wins we can.  

The stock market has cautiously crept upwards, as the market moves to the expectation that high interest rates will cease sooner than previously expected.

The only thing is, crypto has also risen. Not only that, but it has printed gains 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 at all. As inflation comes back down and the likelihood of lower rates and another expansionary period grows, crypto rises. Go figure.

Correlation vs stock market remains high

The proof is in the pudding. It is pretty clear by simply looking at the price chart of S&P 500 vs Bitcoin that the correlation here is stark – with the key lurking variable being interest rates. 

Quite literally, crypto is the opposite of an uncorrelated asset – it has moved in lockstep with the stock market for the last few years. 

Interestingly, there have been periods of decoupling, however. Unfortunately, they have come amid crypto-specific crashes. To show this, I plotted the Bitcoin/S&P 500 correlation against the Bitcoin price over the last couple of years. 

The correlation has been high, aside from a few noticeable periods – all occurring when the Bitcoin price plummeted. The most recent example was November 2022, when crypto wobbled amid the FTX crash. 

There really is no debate here. Crypto is a highly correlated, extreme-risk asset. The only question is whether it can shed this moniker in the long term. But any thought contesting that it is not currently wildly speculative is wide of the mark.

The post Bitcoin’s “hedge” narrative is dead, as speculative price action continues appeared first on CoinJournal.