It’s almost as if nothing but Jerome Powell’s words matter in markets right at this moment.
In looking at the data, it’s kind of true. The correlation between Bitcoin and the S&P 500 over the past year was plotted. The results showed that the correlation has increased over time. This really does shoot down talk of the “inflation hedge” narrative that proved so popular during the pandemic.
But shouldn’t correlations fall with time? But not really. Look back at 2017, and consider the crypto landscape’s texture. 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 that is spilled over it these days.
It is now owned by public companies. This summer, I went to El Salvador and purchased goods with it. These are amazing developments in comparison to just a few short years ago. Bitcoin is now mainstream.
And being a mainstream financial asset – and one that is substantially further out on the risk spectrum – it will indeed be influenced by the market.
2022
This correlation is at all-time highs, and it has been moving in lockstep to the stock market. What caused the upward shift? The interest rate environment is completely different.
Inflation has exploded after a decade with historically low interest rates. This is due to the incessant printing of money and the stimulus spending that was made through the pandemic. To rein in inflation, central banks in the US have had to raise interest rates, with the Federal Reserve leading the charge.
Nothing sucks liquidity out of a market more than rising interest rates, and this is particularly true for high risk assets, such as tech stocks, which discount cash flows back to the present – discount rates which are now measurably higher.
And so – and this is something that is frequently overlooked – Bitcoin is now in a bear market while the wider market is too. Bitcoin is now experiencing a macro environment that is not saturated with quantitative easing and basement-level interest rates. This is the first time Bitcoin has ever experienced this. And it’s creaking at the knees – just like every other financial asset is.
Crises lead to increased correlations. When there is a flight from quality, sellers will be indiscriminate. They seek liquidity and take defensive positions. Cash reserves also rise. Bitcoin is currently experiencing that for the first time ever in its history.
This context explains why it’s no surprise that correlations have risen.
