Bitcoin as an Inflation Hedge: Recent Price Action Does Not Support This

US Inflation Surge

The Covid-19 pandemic caused central banks and governments around the globe to provide unprecedented monetary and fiscal stimulus in order to mitigate the economic fallout. The US Federal Reserve slashed rates to 0-0.25% and launched a massive asset purchases program to support the economy, which ballooned its balance sheet to nearly 9 trillion.

The pandemic also wreaked havoc to global trade, supply chains and forces of supply and demand, issues that have only been exacerbated by the war in Ukraine and the subsequent rally in commodity prices.

These forces have caused inflation to surge around the world, while US President Biden alluded to this causality earlier this month, attributing the problem to the "once-in-a-century pandemic" and "Mr. Putin's war in Ukraine". ^[1]

US Headline Consumer Price Index (CPI) has been climbing, hitting the highest level since December 1981 in March, as it rose 8.5% year-over-year. The most recent data released this month, revealed that Headline CPI eased to 8.3% year-over-year in April, but the figure is still hot and was also higher than expectations.

The Fed's preferred gauge of inflation, the Core Personal Consumption Expenditures (PCE) which excludes food and energy prices, deescalated to 5.2% In March (year-over-year), after having reached the highest levels since 1983 in the prior month (5.4%).

Federal Reserve Reaction to Inflation

Central bank officials had long focused on the other part of their mandate, trying to help the labor market recover from the pandemic shock and characterizing the rising inflation as transitory.

They were eventually forced to change tack and make fighting inflation their top priority, with Mr Powell retiring them term transitory in late November ^[2] and the Fed embarking on aggressive tightening path, which started with the unwinding of its asset purchases program.

The program was concluded a couple of months back and the Fed made the next step by announcing a balance sheet reduction plan this month, to begin in June. It also delivered its first rate hike since 2018 in March and doubled down in May with the biggest increase in 22 years, pointing to more moves ahead.

This front-loaded tightening path however has made markets jittery, as it has created fears of stagflation in the backdrop of the war in Ukraine. The US economy contracted by 1.4% in the first quarter as last month's preliminary data revealed, while Mr Powell had talked of a "soft or softish landing" in his May press conference ^[3] and did not guarantee a soft landing, speaking on Marketplace last week. ^[4]

Bitcoin as an Inflation Hedge

The popular cryptocurrency is often viewed as a good hedge to inflation, since the crypto market is decentralized and is an alternative to the traditional currencies and fiat money. This makes sense in theory, because money loses its value and has less purchasing power when inflation rises.

A look at Bitcoin's performance during this recent period of elevated prices, does not support this theory, as shown by the comparison of BTC/USD and US Headline Consumer Price Index (CPI).

Chart Source: www.tradingview.com

BTC/USD did rise to all-time highs in November (69,023), but has seen had a rather disappointing performance, having lost around 55% from that peak, at the time of writing. During last week's broader cryptocurrency rout, it hit the lowest level since December 2020 (30,379).

US Headline Consumer Price Index meanwhile (blue line), continued its rally up to 8.5% in March, before backing off to 8.3% in April.

Furthermore, BTC/USD (blue line) seems to have a strong correlation to the US tech sector and the NAS100, which is particularly vulnerable to high interest rate and high inflation environments. NAS100 (black line) had rallied to record highs in November (16,711), the same month as Bitcoin, but trades firmly in bear territory, losing more than 25% from that peak at the time of writing.

Chart Source: www.tradingview.com

Other Factors

When looking at the recent price action of Bitcoin, there are other considerations that we need to take into account, such as the fact that it is measured against the US Dollar, which has been boosted by the Fed's aggressive tightening path.

Furthermore, there has been a broader risk aversion, as markets monitor the war in War in Ukraine, China's Covid-19 situation and the prospects of stagflation. The major cryptocurrency is considered by some as a safe heaven and although we have seen some instances in the past when it seemed to be acting as such, this is a status that it has definitely not lived up to.

Another factor that has weighed, is the prospects of tighter regulation, as more and more people invest in the crypto market. US President Biden had signed an Executive Order in March, on ensuring responsible innovation in digital assets, including cryptocurrencies, aiming to address the risks and harness the potential benefits of digital assets and their underlying technology. ^[5]

US Treasury Secretary Ms Yellen had a word of caution during her Senate testimony last week, noting that "digital assets may pose risks to the financial system, and increased and coordinated regulatory attention is necessary", and that "There are many risks associated with cryptocurrencies". ^[6]

Moreover, the US Securities and Exchange Commission (SEC) announced 20 additional positions to the unit responsible for protecting investors in crypto markets and from cyber-related threats, which will nearly double the staff of the newly renamed Crypto Assets and Cyber Unit. ^[7]