Why is crypto following the stock market closer than ever?

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It’s as if nothing but the words of Jerome Powell matter in the markets right now.

Looking at the data, that’s somewhat true. I’ve plotted Bitcoin’s correlation against the S&P 500 since the start of 2017, and the results show that the correlation has generally increased over time. This really knocks down discussions of the “inflation hedge” narrative that has proven so popular during the pandemic.

But shouldn’t the correlations diminish over time? Well not really. Think back to 2017 and the texture of the crypto landscape. It was still a niche asset; it was only beginning to get covered in the mainstream – and certainly nowhere near the level of digital ink prevalent there these days.

Today, we have public companies that own it. I made a visit to El Salvador this summer, where I paid for goods with it. These are remarkable developments from just a few years ago. The thing is, Bitcoin is now in the mainstream.

And being a common financial asset – and significantly further out on the risk spectrum – it will indeed be influenced by the market.

2022

Indeed, this correlation has reached historic highs this year, moving in step with the stock market. What caused the upward shift? The interest rate environment has completely changed.

After a decade of historically low interest rates, inflation has erupted out of control due to relentless money printing and stimulus spending during the pandemic. To curb this trend, central banks were forced to hike, with the US Federal Reserve leading the charge.

Nothing sucks liquidity out of a market more than rising interest rates, and this is especially true for high-risk assets, such as tech stocks, which discount cash flows to the present – discount rates which are now significantly higher.

And so – and this is something that is often overlooked – Bitcoin is now in a bear market while the broader market is as well. Because for the first time in its existence, Bitcoin is experiencing an uninundated macro climate of quantitative easing, basement interest rates, and bullish sentiment. And it creaks from the knees, like any other financial asset.

Correlations increase in crises. Salespeople are blind when a flight to quality occurs; liquidity is sought, defensive positions are taken and cash reserves increase. Bitcoin, for the first time in its history, is going through this the hard way.

In this context, it is not surprising that the correlation has increased.

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