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.

This Week

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.

Stay tuned,

Joseph Orsini, CFA
Director of Research

‍

DISCLOSURES

Investment advisory and management services are provided by Eaglebrook Advisors, Inc., a registered investment advisor. Information presented is for educational purposes only. Past performance is no indication of future results. Please see our Form ADV Disclosures and Privacy Policy in our website.

Price Volatility of Digital Assets – A principal risk in trading Digital Assets is the rapid fluctuation of market price. High price volatility undermines Digital Assets’ role as a medium of exchange as consumers or retailers are much less likely to accept them as a form of payment. The value of client portfolios relates in part to the value of the Digital Assets held in the client portfolio and fluctuations in the price of Digital Assets could adversely affect the value of a client’s portfolio. There is no guarantee that a client will be able to achieve a better than average market price for Digital Assets or will purchase Digital Assets at the most favorable price available. The price of Digital Assets achieved by a client may be affected generally by a wide variety of complex and difficult to predict factors such as Digital Asset supply and demand; rewards and transaction fees for the recording of transactions on the blockchain; availability and access to Digital Asset service providers (such as payment processors), exchanges, miners or other Digital Asset users and market participants; perceived or actual Digital Asset network or Digital Asset security vulnerability; inflation levels; fiscal policy; interest rates; and political, natural and economic events.

Digital Asset Service Providers – Several companies and financial institutions provide services related to the buying, selling, payment processing and storing of virtual currency (i.e., banks, accountants, exchanges, digital wallet providers, and payment processors). However, there is no assurance that the virtual currency market, or the service providers necessary to accommodate it, will continue to support Digital Assets, continue in existence or grow. Further, there is no assurance that the availability of and access to virtual currency service providers will not be negatively affected by government regulation or supply and demand of Digital Assets. Accordingly, companies or financial institutions that currently support virtual currency may not do so in the future.

Custody of Digital Assets – Under the Advisers Act, SEC registered investment advisers are required to hold securities with “qualified custodians,” among other requirements. Certain Digital Assets may be deemed to be securities. Currently, many of the companies providing Digital Assets custodial services fall outside of the SEC’s definition of “qualified custodian”, and many long-standing, prominent qualified custodians do not provide custodial services for Digital Assets or otherwise provide such services only with respect to a limited number of actively traded Digital Assets. Accordingly, clients may use non- qualified custodians to hold all or a portion of their Digital Assets.

Government Oversight of Digital Assets – The regulatory schemes—both foreign and domestic—possibly affecting Digital Assets or a Digital Asset network may not be fully developed and subject to change. It is possible that any jurisdiction may, in the near or distant future, adopt laws, regulations, policies or rules directly or indirectly affecting a Digital Asset network, generally, or restricting the right to acquire, own, hold, sell, convert, trade, or use Digital Assets, or to exchange Digital Assets for either fiat currency or other virtual currency. It is also possible that government authorities may take direct or indirect investigative or prosecutorial action related to, among other things, the use, ownership or transfer of Digital Assets, resulting in a change to its value or to the development of a Digital Asset.