With Bitcoin’s “Digital Gold” Credentials in Tatters, Can It Still Act as a Hedge Against the Upcoming Recession?

Bitcoin

This is not investment advice. The author has no position in any of the stocks mentioned. Wccftech.com has a disclosure and ethics policy.

Over the past couple of months, Bitcoin has firmly established itself as a quintessential risky asset, with the cryptocurrency’s bullish thesis deriving much of its utility from projections of future dominance.

We’ve continued to hammer home Bitcoin’s elevated correlation with the Nasdaq 100 index, which reinforces the risky credentials and heightened volatility of the world’s premier cryptocurrency.

Related StoryRohail Saleem
As BlackRock Launches a Spot Bitcoin Private Trust, the Correlation of the World’s Largest Cryptocurrency With the S&P 500 Index Is Finally Declining

Against this backdrop, many investors are viewing the upcoming recession in the US with trepidation. After all, if Bitcoin is now to be clumped in the broader risk universe, it stands to bleed should an economic downturn materialize in the world’s biggest economy. Nonetheless, the reality is much more nuanced than this simplistic interpretation.

The US Bureau of Economic Analysis (BEA) will unveil the first reading of the Q2 2022 GDP growth rate today. As per Atlanta Fed’s GDPNow Model, the US economy is expected to have shrunk for the second consecutive quarter, thereby fulfilling one of the most important requirements of a technical recession. However, readers should note that a recession in the US is officially declared by the National Bureau of Economic Research (NBER), which takes into account a host of factors, including the health of the labor market. Consequently, even if the BEA unveils a negative GDP growth rate print today, it is unlikely that the NBER will declare a recession given the still-robust broader labor market.

The risky asset universe in the US is being impacted by two key factors right now:

  • The inflation trend and the attendant trajectory of the interest rates
  • Growth concerns and the growing expectation of a recession

Throughout much of this year, the first factor mentioned above reigned supreme, hammering high-beta, growth-focused stocks that derive much of their bullish thesis from the present value of future cash flows and which stands to be discounted much more heavily in an environment of rising rates. The initial correlation between Bitcoin and such stocks was established as a result of synchronous liquidation waves earlier this year, where institutional investors dumped their Bitcoin holdings to finance margin calls on their other drowning positions. Now, this mentality has been firmly established, leading to a persistently high correlation between Bitcoin and growth-focused US stocks.

Recently, however, as economic deceleration fears started to grow amid relentless interest rate hikes from the Federal Reserve, the market has flipped its narrative where the bad news is good news again. The rationale underpinning this narrative is quite simple: with a majority of economic indicators flashing the proverbial red signal, it is only a matter of time until the Fed abandons its hawkish interest rate path and loosens financial conditions. As for inflation, the view goes that the upcoming recession or even a prolonged economic deceleration would be sufficient to recapture this genie in the bottle. This, of course, bodes well for Bitcoin and high-beta US equities.

Yesterday’s FOMC meeting had attracted a lot of attention as investors eagerly tuned in to gauge any inkling as to the Fed’s capitulatory mood vis-à-vis its hawkish interest rate path. Interestingly, while the statement that accompanied another baked-in increase of 75 bps in the Federal Funds rate was quite generic, Jerome Powel did throw the market a bone in the ensuing presser, noting:

Related StoryRohail Saleem
Ethereum’s Crashing Transaction Fees Are a Symptom of a Lack of Demand as Users Await the “Merge” Event

“[It would be] likely appropriate to slow [interest rate] increases at some point ….”

Powel also stated that any further interest rate increases will be “data dependent.” This proved to be music to the market’s highly attuned ears, with equity indexes and Bitcoin all recording outsized gains in the aftermath.

This brings us to the crux of the matter. Apparently, Fed officials believe that the strong labor market in the US will allow the economy to sustain the rapidly tightening financial conditions, allowing inflation to auto-correct as the aggregate demand in the economy slows down. Should the reality follow this narrative, the risk universe, including Bitcoin, is due rip-roaring gains in the near future.

However, consider a scenario where the inflation remains persistently high, aided by the consistently strong labor market. In this situation, the Fed’s hands would be bound, and the much-anticipated easing will not materialize. An even more devastating scenario would be one where the inflation decelerates momentarily, allowing the Fed to pivot toward a dovish monetary policy, only to see inflationary impulse re-accelerating.

This brings us to the crux of the matter. Under a typical recession, earnings crash as layoffs sap the spending power of US consumers, leading to substantially lower equity valuations. In fact, the S&P 500 index typically retreats around 35 percent from its all-time high in a recession. Bitcoin, however, is a non-traditional asset and, as such, it does not have any direct linkages to the aggregate demand in the US economy. Of course, fund flows play an important role in driving Bitcoin’s price, but this is a second-order effect. Consequently, once the Federal Funds rate peak later this year, the tightening financial conditions headwind for Bitcoin and the wider risky asset universe will dissipate. Any recession that then materializes would provide Bitcoin the opportunity to disassociate with its persistently high correlation regime with US equities, allowing the world’s premier cryptocurrency to rebuild its credentials as a viable hedging instrument.

At present, however, we see no indication that Bitcoin is about to forgo its torrid love affair with growth stocks. Until this regime continues, the cryptocurrency would prove to be a futile hedge against macroeconomic shocks.

Update: US Economy Contracts by 0.9 Percent in Q2 2022

Source: https://www.bea.gov/news/2022/gross-domestic-product-second-quarter-2022-advance-estimate

The US economy has contracted for the second consecutive quarter, fulfilling one of the most important conditions for a technical recession. However, as stated above, the NBER is unlikely to decalre a recession given the continuing strength in the labor market.

It remains to be seen how today's GDP report affects Bitcoin and the broader risky asset universe.

WccfTech Tv
Subscribe
Filter videos by
Order