Bitcoin in the face of rising interest rates
Perhaps one of the most plausible explanations of the observed inflation today is that the gears didn’t work as expected, since QE (Quantitative Easing) — monetary policy used by Central banks to stimulate national economies, often used unproductive, when companies used low yield of bonds to repurchase shares, and not for growth initiatives. It took the global health crisis (COVID) to expose a flimsy global logistics network, and significant supply shortages that helped push inflation to levels not seen in the US since June 1982.
In the last minutes of the FOMC meeting that took place yesterday, we saw that the Fed is increasingly concerned about the risk of inflation in the SH. This forces them to consider the possibility of ending the reduction of the QE program earlier than the markets expected. At the same time, the possibility of four rate hikes in 2022 is being considered, rather than two, as expected about six months ago. This time, it looks like the Fed may stop cutting deadlines and raise rates again, as it started doing in 2015.
What will happen to Bitcoin in the face of rising interest rates? Bitcoin, according to Coinmarketrate.com, increased by 51% 6 months after the first rate hike in 2015, and since then Bitcoin has matured significantly and therefore is likely to behave differently and in line with other real (inflationary) assets or tangible items. Therefore, an analysis of the behavior of other real assets in previous cycles of interest rate increases can give us an idea of how the king of the cryptocurrency market may behave.
The anatomy of an interest rate hike
Although each historical cycle of rate increases is somewhat different, there are also common features. To best represent today’s scenario, we have identified five of the nine possible periods of rate hike cycles after Bretton Woods.
The periods of December 1976, December 1986, February 1994, June 2004 and 2015 are the closest to today’s scenario, since these are periods when interest rates either fell or were relatively low for a long period of time. It is encouraging that the analysis shows an amazing sequence in each of the five observed periods.
Gold is an example of inconsistency: in 1976, 1986 and 2004, prices rose by 22%, 25% and 11%, respectively, and in 1994, a year after the first increase in interest rates, they fell by 2.6%. Inflation was probably the cause of price increases in 1976 and 1986, but not in 2004, when inflation was better controlled. An important distinguishing feature of 1994 was that real interest rates rose by 3%, while in other periods they were stagnant or negative, which confirms that the growth of real interest rates is usually negative for gold.
Industrial goods, another real asset, tend to behave in a similar way in cycles of interest rate increases. The S&P 500 is technically a real asset and tends to initially rise, but then begins to fall, probably due to tighter credit conditions affecting corporate profitability.
Before interest rates were raised, the US dollar exchange rate, as a rule, remained unchanged or increased, but then it was volatile in each case, falling by an average of 7% per year. This fact may seem counterintuitive, since the tightening of the money supply leads to a decrease in the number of dollars in circulation. We believe that the most likely explanation is that markets tend to fully assess the prospects for strengthening the economy and improving the situation in the labor market before this event occurs. It seems that the US dollar behaves in a similar way: since November 2021, the US dollar has risen against a number of currencies, while Bitcoin, which is traded inversely proportional to the US dollar, has experienced a wave of sales.
The Fed is lagging behind the trend, which increases the risk of an error in monetary policy
Monetary policy should be proactive, and since inflation is a lagging indicator of the state of the economy, it can be argued that the Fed is already lagging behind the trend. It should be remembered that monetary policy affects the economy with a lag of 1 to 2 years, so the increase in interest rates that began today is unlikely to have an immediate impact.
The liquidity created by QE and exceptionally low interest rates have posed a serious challenge for the Fed. With the gradual reduction of QE (tapering) and the beginning of an increase in interest rates, the risk of a disorderly correction in the equity and bond markets, which relied so heavily on these incentives and reached record heights, increases. On the one hand, the Fed has a mandate to control inflation, but on the other hand, it also has a mandate to ensure stable prices. Therefore, it is very difficult to understand how the Fed can control both at the moment.
It is also necessary to take into account the power of the Fed (the amount by which interest rates can be raised), and at first glance, household debt service ratios look healthy: on average, 9.1% of household debt goes to debt service, which is the lowest indicator since the beginning of accounting.
Corporate debt also looks healthy: the ratio of net debt to EBITDA (debt load ratio) is 1.3 years compared to the long-term average of 1.7 years. This suggests that the Fed has significant scope to raise interest rates before they put pressure on the economy.
Real assets are likely to benefit
However, there are some sectors of the economy where the ratio of net debt to EBITDA does not look the best, in particular, utilities, energy and healthcare, which are in a worse position today than shortly before the financial crisis of 2008. Net debt to EBITDA in the technology sector, although higher than at any time since 1998, still remains low compared to other industries. One of the unintended consequences of raising interest rates too aggressively may be an increase in defaults and unemployment in these important sectors of the economy, which will lead to social unrest and greater political instability.
So, Bitcoin is likely to behave the same way as gold and other real assets, since its price is determined in US dollars and there is a fixed supply.
We have already seen how Bitcoin became extremely sensitive to the threat of interest rate hikes in December 2021 and January this year, falling by more than 40% from its highs, which, in our opinion, is a reaction to inflation and the growing likelihood of an increase in the number of rate hikes in 2022.
In the long run, we see a high risk that the Fed will make a policy mistake (it will wait too long and then raise rates too aggressively), and the US dollar will sell off, and both of these factors are likely to support Bitcoin and other real assets.