Recently, Tom Lee said that there is a clear correlation between the Emerging Markets (EM) and Bitcoin (BTC). Indeed, the correlation between these markets is visible, although not so obvious now, since the influence of institutional players is not yet so great. But it may change very soon; the correlation will increase (from the beginning of the year it is more than 0.65 relative to EEM ETF). Let’s have a look at what is happening with emerging markets. They grew steadily until 2017 when there was a reversal of the trend in the cycle of monetary policy easing. Many people believe, that cycle came to an end in 2012–2013, linking this event with the completion of QE in the US. That’s not true. It lasted until the beginning of 2017, as the ECB and the Bank of Japan continued to inject liquidity into the markets in the amount of almost $200 billion per month. The reversal of this trend occurred in the second half of 2017, when the ECB and the Bank of Japan decreased their volume of purchases, and the US Federal Reserve began to reduce the balance.
As per recent news, let’s pay attention to the speech of the head of the Federal Reserve (08/24), which turned out to be quite optimistic for the market. Despite the confirmation of the smooth tightening of monetary policy, the statement had a gentle tone. This, in turn, immediately affected the futures on the rate, which fell to a probability of 66% increase in December (the probability of an increase in the September meeting is now 100%). The EM reacted strongly, and it should be noted that the crypto-currency indices have also bounced quite well after Powell’s speech, and BTC broke $7K level for a while.
Let’s get back to the EM. Which indicator can be defined as determining for developing areas? There are several of them, but one of these leading market indicators is the Tbonds curve (the correlation since the beginning of the year is more than 0.8). If this can be one of the main, sometimes leading indicators, then we can directly track the correlation with the main cryptocurrency. So, we tried to look at the correlation between the spread of short and long Tbonds and the BTC, avoiding the EM.
Appetite for risk began to decrease, and we can now see the flow of funds to developed markets, mainly in the US. At the same time, the allocation of portfolios tends to favor bonds with a long duration. This indicates the declining of the risk appetite, which affects all volatile markets. Through the example of the US Treasuries, we see an increased demand for 10-year bonds, having narrowed the spread with 2-year bonds yield. This, in turn, leads to the effect of a flat curve (the long part on yield curve begins to decrease and the graph shows that the curve is flattened). In brief, why it happens. Remembering macroeconomics, we can conclude that the cost of long-term funding is a balance of savings and investments. If the investment demand is growing and there is distinct economic growth, then long term yields are growing. If the situation in the economics changes for the worse, the investment does not bring resonable return and the need for savings increases. That affects the long term yields, that goes down (I remind you that the price and yield in bonds are reverse concepts, i.e., if the price increases, it means that the yeild decrease, if the price falls, then vice versa).
According to statistics, the narrowing of the yield spread of T10 to T2 is rather a warning anticipatory indicator for high risk assets and even for low risk peers. In spite of that, we do not expect a serious massive panic sale in the next year. Historically a serious problem begins to come out when the curve becomes inverted (long yields are lower than the short ones). Based upon the dynamics, we expect that this will happen in late 2019 — the first half of 2020. Taking into account the assumption that the crypto market correlates with EM, and when more and more regulation appears, institutional investors’ will include the crypto assets in their portfolios more actively. Next year, this correlation may be significantly higher. Therefore, the analysis of the situation and work on the crypto market shortly will require a more integrated approach.
Despite the fact that in the long run (next 1–1.5 years) a pessimistic scenario may take place and risky assets including cryptocurrency can be under significant pressure, we can assume, that a reversal pattern in BTC (due to weekly time frames) can bring the main cryptocurrency to the range of $ 10–11K in the short to mid-term basis.
