Inflation, Interest rates, and the Crypto Bear Market
In this article, I will give you data to help you understand the macroeconomic outlook and how it relates to cryptocurrency. Before anyone else, let me state unequivocally that I am not a macroeconomics expert.
This article was written because there is simply too much misinformation out there, particularly on Twitter.
US money supply
I’ll focus on the United States because it has the world’s largest economy.
During the COVID pandemic, many businesses had to close, resulting in unemployment and people losing their jobs.
Because businesses and people needed money, the government decided to assist in various ways, such as stimulus checks. So, what does the government do when it suddenly needs a large sum of money?
Because money is backed by nothing, the FED can simply keep printing money as they want, which is exactly what they did.
Let us examine the US dollar money supply:
As you can see the government started accelerating money printing early 2020, almost doubling the supply by the end of 2022.
Why is this a problem?
Basic supply and demand dictate that the more of a good there is, the less valuable it is. This also applies to money.
A simple example:
Let’s say a can of coca-cola, pre-covid, cost 2$.
All of a sudden, people get access to cheap money via cheap loans (interest rates were low) and government stimulus.
The economy is thriving!
People now have more money, so they spend more money.
As more people now can afford that can of coca-cola, demand for that can will increase.
Basic supply & demand dictates that as demand increases for the same supply, price will to go up.
Because of increased demand, that can of coke will now cost 2.05 $.
The above example applies to consumer goods, housing, food, electronics, etc etc,…
Inflation is a decrease in the purchasing power of money, reflected in a general increase in the prices of goods and services in an economy.
Next to the fact that people had access to cheap money, they had a lot of time on their hands (quarantine) which led to a lot of retail investors investing in cryptocurrencies.
The disadvantage was that inflation was rising at an unseen pace.
Below chart shows the US year on year inflation rate:
As you can see inflation inflation has gotten out of control, now reaching it’s highest level since the 1980's.
On top of this we had the war in Ukraine war which led to a lower supply of gas (pushing the energy prices up) and a lot of supply chain issues (supply down => price up) which accelerated inflation even more.
As you see the principle of supply and demand applies to many different things.
Prices started to get out of control, the fed had to act and so they did.
When inflation is high, what you want to achieve is that money comes out of circulation, people spend less money, decreasing demand and thus the price of most goods.
The FED does this by rising interest rates, which basically is making access to money (lending money) more expensive.
This leads to:
— Consumers spending less.
Whereas before they paid 1% interest for their mortgage, now they pay 2% (just an example).
The increased cost of living => less spending.
— Businesses will invest less since it’s more expensive to lend money now, which means they create less work, which means there’s less money to be made on the job market.
— Saving accounts becomes more interesting as interest on US bond rise => people park their money => less money in circulation => less spending => decreased demand => decreased prices.
Usually rate hikes are quite effective against inflation, however now, due to the Ukraine war & supply chain issues, even after several rate hikes we haven’t seen inflation come down yet.
This can only mean that the FED will have to hike rates again, and aggressively, meaning a lot of people will suddenly be exposed to a quick increased cost of living, which can potentially lead to a recession.
What does this have to do with cryptocurrencies?
Investors know that rising interest rates lead to less economical growth and possible to a recession, which is why they started de-risking on their assests.
How do they anticipate this recession?
By selling assets for fiat, assets being stocks and…cryptocurrencies.
Look at the chart below.
The first chart shows US interest rates where the second shows the BTC price and the third the SP500 (stocks)/
You can see that the stock- and the crypto-market already started to price in the possibility of an interest hike when the FED announced they will change their monetary policy, somewhere around November 2021.
Cryptocurrencies are considered as high-risk assets, as opposed to oil or gold for example, which is why often they are the first ones to get hit during uncertain times, together with tech-stock.
Bitcoin is basically the stock market on steroids and has always been strongly correlated with it.
Below in yellow the BTC chart and in blue the S&P 500.
You can see BTC has always followed the SP500 more or less, which is an index of the 500 largest companies listed on a stock exchange in America.
I think it’s super important to take a look at the above chart so you can see for yourself that what is happening now is just a sell-off in (risk)-assets on the global market, and not some random coincidence that just happened without a reason.
Of course on top of this we had Luna, Celius & 3AC which caused crypto to crash even further.
Back to inflation and interest rates.
There are 2 scenario’s:
Scenario 1 (which, IMO, is most likely to happen):
Because of supply chain issues, the Ukraine war & the energy crisis, the current interest rate hike is not enough and the FED will go for a hard landing, meaning they prefer going into a short recession rather than another period of sustained inflation by agressively rising interest a couple of more times.
A recession is defined as, in theory, a period of 2 quarters with negative economic growth.
If we go into a recession there will be:
Zero retail interest in buying cryptocurrencies
People who before didn’t want to sell their crypto, now will have to to pay for gas and rent
Companies will start to lay-off people
Crypto projects will run out of funds, go bankrupt and get even more negative media attention
If the above happens, take your charts, your ranges, your previous all-time-highs, your moving averages and throw them in the bin.
They’ll all be worthless as in the past, the macro-outlook was completely different.
I’d like to emphasize that personally, I don’t think politicians will let us go into a long & sustained recession.
This time, they’ll probably see the recession coming, which means they’ll be able to anticipate it’s consequences.
I’m expecting max pain between now and somewhere by the end of the year, after the US elections.
Via the current interest rate hike, the FED manages to control inflation.
We see improvements on the macro-economic horizon (Ukraine, energy,…) and we go for a soft landing.
This article might give you some context on the situation:
You’ll see the FED saying this like: we’ll go for a soft landing, blablabla.
Don’t forget that 6 months ago they were saying ‘inflation is only transitory’.
There is a big difference in tone between Biden and J Powell as well.
Biden claims we won’t go into a recession and it’s Putin’s fault, whereas Powell says a recession is not unlikely.
Needless to say, they both have different incentives.
What about crypto?
In scenario 1, I wouldn’t be surprised to see another 20–30% decline in Bitcoin.
When you have to worry about paying your rent, buying crypto will be the least of your worries.
If we go into a recession, I expect a lot of teams to cash out for real life expenses, abandoning their project.
In scenario 2, we’Il be rather close-ish to the bottom but not there yet.
But again, I don’t think this scenario is very likely.
As a good investor, you can have a bias for certain scenario’s, like me having a bias towards scenario 1. However, good investors are always prepared for all possible outcomes by playing both sides.
During times like these, you’ve probably heard phrases like “DCA is your friend.” In theory, dollar cost averaging involves purchasing small amounts over a set period of time regardless of price movement. If you are a long-term investor, starting with X $ per week/month/…. is probably not the worst idea.
Don’t, however, be the guy who buys the dip that keeps dipping. Personally, I prefer to buy the dip rather than simply investing X $ every month, and because I believe we are not yet at the bottom, I am not currently buying. I’m more of a long-term holder than a buyer or quick seller, and I’m content to load up on each dip and simply hold.
I have a strong bias for BTC going lower than 17 800$ again, which is why I haven’t set any buy orders yet. BTC looks weak & macro looks even weaker, so nothing to rush about now.
To cut a long story short, I believe BTC will stabilize once interest rates stop rising aggressively and inflation begins to fall. Nobody knows when that will happen, but I doubt the FED will let this situation spiral out of control because they will see it coming. We’re looking at a timeframe of 6–10 months. I’ll keep an eye on things and keep you posted on when I think it’s a good time to buy certain items.