There’s a disconnect between crypto markets and Wall Street.
Among bitcoin bulls, a key investment thesis is the trillions of dollars of money injections by global central banks will usher in an era of inflation, helping to send prices for bitcoin, seen as a hedge against inflation, to the moon.
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But trading in global bond markets shows traditional investors expect nothing like the hyperinflation episodes witnessed in places like Zimbabwe and Venezuela.
Just look at breakeven inflation rates – calculated by assessing the difference between yields on inflation-linked notes and regular bonds. It’s a way of gauging traders’ expectations for future inflation, and the current view is that consumer-price increases over the next five years in the U.S. will average levels well below the Federal Reserve's 2% target.
As of Wednesday, the five-year breakeven rate was 1.5%, according to data provided by the Federal Reserve Bank of St. Louis.
That’s down from 1.8% in September – even after the Fed injected more than $3 trillion of new money into the financial system just this year.
The analysis offers a reminder of just how deflationary recessions can be, with rising unemployment that often puts downward pressure on wages and consumers’ demand for goods and services. A report Friday from the U.S. Labor Department put the May unemployment rate at 13%, up from 3.5% in December. Millions of people lost their jobs as businesses slashed their workforces during this year’s coronavirus-induced lockdowns.
“Typically, inflation is going to be linked with employment levels,” Rich Rosenblum, a former Goldman Sachs managing director who’s now co-head of trading at the cryptocurrency-focused firm GSR, wrote in an email. “If the U.S. inflation was below target (sub 2%) when the country was at full employment, then it's even less likely that inflation will arrive when unemployment is sky high.”
Europe and other parts of the world are facing similar situations. While the European Central Bank (ECB) has amassed assets worth over 5 trillion euros, five-year inflation expectations remain at a meager 1.02%, as noted by macro analyst Holger Zschaepitz. The ECB also targets 2% inflation.
Traditional investors may be keying off recent experience showing that large-scale central bank money injections over the past decade have not touched off anything resembling hyperinflation.
The Fed conducted multiple rounds of asset purchases in the six years that followed the 2008 crash, more than quintupling its balance sheet to about $4.5 trillion from $800 billion. Throughout that period, the core inflation rate, which excludes food and energy items whose prices can be volatile, remained well below the central bank’s 2% target.
Could this time be different?
According to Mark Thornton, a senior fellow with the Ludwig von Mises Institute in Alabama, the direct cash handouts to ailing businesses and households might start the new money sloshing around the economy sooner than in 2008, when the Fed mostly relied on banks to lend out the funds.
And GSR’s Rosenblum says unforeseen events, such as heightened geopolitical conflict, could push prices higher. Tensions between the U.S. and China escalated in May, with Washington criticizing Beijing’s handling of the coronavirus outbreak as well as its move to curb Hong Kong’s autonomy via a national security bill.
An unexpected choke on “supplies of certain goods (e.g. oil, semiconductors) could cause a surprise rise in inflation,” he wrote. “Even if this rise is temporary and merely a scare, it can be quite damaging.”
One possibility is the Fed’s new money injections haven't really found their way into Main Street commerce as much as onto Wall Street – propping up prices for financial assets like stocks and bonds.
The Standard & Poor’s 500 Index of large U.S. stocks has rallied more than 40% from March lows and is about 8% short of challenging record highs seen in February. Other major equity indices, too, have witnessed stellar rallies.
With few signs of rising inflation, then, and traditional financial markets rallying, big investors might have fewer reasons to pour money into a perceived inflation hedge like bitcoin.
GSR’s Rosenblum noted that bitcoin’s value is in hedging against the risk that inflation might eventually pop up: There’s little to worry about right now, but the deep economic dislocations from the coronavirus and ever-shifting geopolitical winds have created ripe conditions for price spikes to emerge.
“It is more about picking the right instrument that would build in a risk premium if inflation expectations rapidly shifted in the future,” Rosenblum said.
Tweet of the day
Trend: A bitcoin price indicator is about to turn bullish for the first time in 12 months.
The 50-candle moving average (MA) on the three-day chart is on track to cross above the 100-candle MA in the next 24 hours. The resulting bullish crossover would be the first since mid-June 2019 and the third since October 2015.
Last year, bitcoin's upward move from $4,000 to $9,000, seen in the 2.5-months to mid June, accelerated following the same bull cross. Prices rose as high as $13,800 by the end of the month. Meanwhile, the crossover seen in October 2015 marked the beginning of the mega bull run from $250 to $20,000.
However, the cryptocurrency's recent failures around the $10,000 mark are indicative of buyer exhaustion.
"Technical analysis comments that until the buyers reclaim $10,500 (February high) resistance as a new support, we would not only not see $11,600-$12,000 supply area tested, but also bitcoin remains at risk of validating bearish rising wedge pattern with target around the $7,600s," said Adrian Zdunczyk, a chartered market technician and CEO of trading community The BIRB Nest.
While $10,500 is the level to beat for the bulls, last Tuesday's low of $9,135 is the key support to defend. If breached, bitcoin may see a deeper decline toward $8,600.
At press time, bitcoin is trading largely unchanged on the day near $9,745, having recovered from lows below $9,400 over the weekend.
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