Last week, bitcoin traded in a narrow range with a low of $46,798 and a high of $51,970, ultimately closing 1.5% higher by the end of Sunday’s close. After experiencing three weeks of declines, the relatively low volatility week was a relief to investors, with bitcoin continuing to trade around the $50,000 level.
Currently, the market remains focused on inflation: headline CPI came in at 6.8% year-over-year, a four-decade high and the seventh straight month of year-over-year growth above 5%. Core rose 0.8% month over month, and consumers continue to feel pricing pressures in everyday living.
So why hasn’t bitcoin rallied? This week, we discuss inflation, inflation expectations, and the difference between the two.
CPI Print Highest in Four Decades
Transitory or not, inflation continues to accelerate, with headline CPI rising to 6.8% from 6.2% in October, and Core CPI rising 4.9%, up from 4.6% in October as well.
Initially, bitcoin rallied after the print, but pulled back as investors digested the potential for a hawkish Fed. Bitcoin traders saw this inflation print as "priced-in" and thus, "sold the news."
Little Relationship Between BTC % Change and M/M Inflation
In fact, we see very little relationship with month-over-month inflation and the daily return of bitcoin on the day of the release.
While bitcoin is theoretically an inflation hedge given its hard-coded, scarce supply structure, these moves aren’t direct and often take place over time:
When assessing consumer price increases on a variety of goods since December of 2019 to November of 2021, we see that bitcoin has outpaced the growth in many of these cost-of-living goods:
So while bitcoin does not rally relative to the print on the day of the release, it often outpaces traditional inflation measures over time, as traders and investors often position themselves for the future rather than the current market environment.
Now, Expectations Matter
The Federal Reserve’s process of normalization remains a leading focus for both investors and traders, and thus, bitcoin has traded more in-line with inflation expectations rather than the level thereof.
Tapering and tightening schedules have been the conversation for months now, and participants have certainly considered the potential for the Fed to reduce inflation through quantitative tightening and the hiking of interest rates.
With three hikes now on the table for 2022, inflation expectations have declined from their highs. Utilizing a market-based measure such as the breakeven rate, we see that bitcoin has moved lower in tandem with recent inflation expectations:
Regardless, They Will Print Again
Whether inflation and expectations have peaked or will continue to persist, the bigger picture is that the Federal Reserve has continued to print despite many months of inflation above their 2% objective.
Keywords such as “average inflation targeting” and “transitory” have been used to keep the printer running. Even as many market participants forecasted and warned of the very inflation numbers we’ve experienced, the Federal Reserve has just now decided to "retire" the word "transitory."
While we believe the Federal Reserve has done the right thing in remaining accommodative as the economy moves past the pandemic, this willingness and tendency to be overcautious and maintain aggressive stimulus programs must not be forgotten.
The accommodation seen since the pandemic illustrates to many bitcoin investors the extent and magnitude policymakers are willing to go: M2 Supply rose 24.8% in 2020 and has risen almost $6 trillion dollars since December of 2019, and inflation has remained over 5% year-over-year for seven months now.
Investors can only believe the next response will be bigger and "more accommodative" than those in the past - a trend that bodes very well for long-term investors in bitcoin.
Remember, Inflation is One Part of The Story
While inflation expectations are today’s short-term price action narrative, bitcoin’s network effects and levels of adoption continue to lead the charge in longer-term price discovery.
These factors, such as growth rates faster than the internet, a growing use as a medium of exchange, and the significant interest from institutional investors, drive price discovery over longer periods of time.
Bitcoin benefits from secular trends towards digitalization, innovation, and technology, and macro events such as the accommodation response are significant catalysts for pull-forwards in demand.
Today’s concerns over a reduction of the “punch bowl” are ultimately short-term narratives in a much longer demand story. Volatility as a result of uncertain monetary policy provides opportunity for long-term bitcoin investors who understand that performance relies on a multitude of factors, rather than just today's inflationary environment.
On Wednesday, the market will learn whether Fed Chair Jerome Powell and the FOMC will increase the pace of tapering. Market participants will remain focused on how risk-assets respond to hawkish changes in monetary policy, if the Fed decides to shift in this direction.
As we believe, transparency remains key for the Federal Reserve to maintain orderly markets – bitcoin included. Powell has remained incredibly transparent, which ultimately reduces concerns of further unexpected changes in policy and thus, unexpected volatility.
As always, please reach out with any questions or comments.
Joseph Orsini, CFA
Director of Research