Just under a month into this shiny new year that is 2023, and markets are heating up.
Inflation has softened significantly over the last couple of months. The bane of markets all throughout last year, this has provided hope to investors that the Federal Reserve will pivot from its hawkish interest rate policy sooner than was previously anticipated.
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It is nearly a year since the economy transitioned into this new interest rate paradigm, with rates rising from zero to north of 4% and counting.
Inflation coming down, markets released
Rates were the weapon of choice in the battle against the worst inflationary crisis since the 1970s. As CPI numbers came in hotter and hotter, it became apparent there was a big problem. The Fed knew this, and it didn’t hang around – kicking into gear one of the fast hiking cycles we have ever seen.
It has worked. Finally. Inflation has begun to fall.
In fact, the main fear now is that the tightening cycle has gone too far, with concerns that a recession is looming the main cause for hesitancy in the market, rather than inflation.
Ironically, if you need evidence inflation is coming down, you just need to check how far cryptocurrency prices are rising – it’s nearly as indicative as the CPI report itself.
I say ironic because cryptocurrency, or rather Bitcoin specifically, was previously touted as an inflation hedge. Its hard-capped supply is programmed not to debase, unlike its fiat counterparts, the theory went.
Of course, nothing was further from the truth. USD may have lost 10% to inflation over the past year, but Bitcoin lost 75%. Go figure.
Now, with inflation softening, Bitcoin (BTC-USD) is off to the races again. It is up 38% on the year, trading at $23,000 following a brutal year. It’s the strongest rally in 9 months for the sector.
As it has been doing for a long time now, it continues to trade like a high-risk asset, hence it is benefitting more than most from the expectations of a more dovish monetary cycle coming down the tracks.
The below plots it against the Nasdaq (IXIC), the tech-heavy stock index, its correlated yet less volatile cousin, which is also having a nice start to the year, up 8%. It peeled back 33% in 2022.
Bitcoin the best-performing asset class of 2023
In fact, in Goldman Sachs year-to-date report this week, it even announced that Bitcoin is the best-performing asset class of the year so far. It assessed the Sharpe Ratio of various asset classes, which means it plotted the price increase against the volatility of each asset class.
Obviously, this is just a 25-day sample, but after what was a year from hell last year, the respite is a huge win for crypto investors.
It’s important to remember why, however. There is no underlying positive news coming out of the industry this year that justifies a 40% pump in prices. In fact, the news cycle has been quite negative. Crypto lender Genesis filed for bankruptcy, rumours continue to swirl around Gemini, while more layoffs have come at Coinbase, Crypto.com and a host of other crypto companies.
But as we know by now, Bitcoin trades like an extreme-risk asset. And with inflation coming down and hopes of a Fed pivot increasing, that means it’s going to rise. Just don’t go calling it an inflation hedge.