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Even bitcoin and crypto can’t fight Fed interest rates

Fed Chair Jerome Powell and Janet Yellen Testify at Senate Hearing on COVID-19 and the CARES Act

Alex Wang

Bitcoin (BTC-USD) has long been championed as an alternative asset class. Now, at a time when many investors are seeking just that, bitcoin is more correlated with bitcoin at a time when stocks are taking one hit after another as the Federal Reserve continues to hike interest rates stock exchange than ever. As Bitcoin becomes more mainstream, I don’t expect this trend to reverse. All of this is problematic for Bitcoin as an asset.

September 0.75 basis point rate hike tanks bitcoin

On Wednesday, the Federal Reserve met and approved another hike of 0.75 basis points. In addition, they made it abundantly clear that curbing inflation is the Fed’s top priority:

The Committee’s long-term goal is maximum employment and an inflation rate of 2 percent. In support of these goals the committee decided to raise the target range for the federal funds rate to 3 to 3 1/4 percent and believes that continued increases in the target range will be appropriate. Additionally, The Committee will continue to reduce its holdings in government and government bonds and mortgage-backed securitiesas outlined in plans to reduce the Federal Reserve’s balance sheet total, released in May. The Committee is firmly committed to returning inflation to the 2% target.

This subsequently sent the stock market into a tailspin. But it also sent bitcoin down. If the goal of Bitcoin and other cryptocurrencies like Ethereum (ETH-USD) is to “decentralize funding” and provide an alternative asset class for investors, Wednesday’s performance was highly problematic.

diagram
Data from YCharts

The chart above shows SPDR’s ProShares Bitcoin Trust (BITO) and SPDR’s SPY ETF (SPY) moving in near sync following the Fed’s 2pm announcement.

Recent research shows that Bitcoin is increasingly associated with stocks

This connection is neither purely anecdotal nor a one-off event. According to a study published in January by the International Monetary Fund

The results suggest that the interdependence between crypto and stock markets increased significantly between 2017 and 2021.6 For example, compared to the years prior to the pandemic, the correlation between bitcoin price volatility and S&P 500 volatility has increased. Index More Than Quadruple, While Bitcoin’s Contribution Helped S&P 500 Index Volatility is estimated to have increased about 16 percentage points in the post-pandemic era.

Bitcoin’s volatility is generally much higher than that of the stock market and is increasingly correlated with stocks. This correlation quadrupled between 2017 and 2021, according to the study:

Correlation between stock market and bitcoin

“Cryptic Connections: Spillovers Between Crypto and Equity Markets” (Tara Iyer, Published IMF)

The spillover effect from the S&P 500 (SP500) onto Bitcoin has increased even more than in the opposite direction, suggesting that stock markets are increasingly deciding crypto’s movement:

For example, between 2017-19 and 2020-21, Bitcoin and Tether volatility spillovers on the S&P 500 increased by about 16 and 6 percentage points, respectively, while S&P 500 volatility spillovers on Bitcoin and Tether increased by 13-15 percentage points (Figure 5). Similar, Return spillover from bitcoin and tether to the S&P 500 are up 10 and 6 percentage pointsduring this in the opposite direction increased by 12-13 percentage points (Figure 6).

This increased correlation was called “temporary” in a report by 21Shares, suggesting that this is only a short-term phenomenon and that long-term crypto remains useful for asset diversification. Given the significant rise in recent years, however, the notion of crypto and stocks decoupling again is questionable.

This is mainly because Bitcoin is no longer a niche asset alongside Ethereum and other major coins. Institutional investors have crowded into the crypto space, and with a lack of fundamentals to guide buy and sell decisions (as one might suspect with stocks), crypto trades quickly on swings in sentiment.

And sentiment never swings like it does when Jerome Powell hikes interest rates.

Bring away

One of the problems with discussing bitcoin trading separately from the stock market is that such decoupling often assumes a calm market environment. For example in this June article:

Despite hitting a 17-month high correlated with the S&P 500 this year, Bitcoin has a proven track record of actually remaining uncorrelated from stocks. As market conditions become more secure, Bitcoin will return to its normal self and trade uncorrelated.

But the time when you most want an asset class that isn’t correlated to the stock market is in an inflationary market that’s facing significant downward pressure. Unfortunately for crypto investors, the opposite is true.

Ironically, Bitcoin’s adoption appears to be its downfall as well. As Bitcoin is increasingly accepted by mainstream financial services providers, it loses its value and becomes just another asset in a basket. Decentralization is of little use when your assets are owned and managed by the largest banks in the world.

I’ve already discussed why I don’t hold Bitcoin as an actual currency. However, it is becoming increasingly clear that Bitcoin is not a very good asset class either. It is highly correlated with stocks, except that it is more volatile in a hostile market environment. To me, that means now, maybe more than ever, is a good time to keep your distance.

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