Bitcoin and Crypto Brace for Further Rise as Stocks Seek to Extend Recent Gains

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The long-awaited 2022 recession and bear market rally that many expected has not materialized so far in 2023. In fact, most assets have been bid on, with the Nasdaq hitting a high of 52 weeks on July 12.

How is this possible, and will the rally continue?

Michael Burry of The Big Short fame said in January that the United States could be in recession by the end of 2023, with a lower consumer price index (CPI) and reduction rates Federal Reserve (note last week’s CPI print is well below expectations, further fueling the recent rally). This would lead to another spike in inflation, he said.

Recently, independent macro and crypto analyst Lyn Alden explored the topic in a newsletter published this month.

In the report, Alden examines today’s inflationary environment by comparing it to two similar but different time periods: the 1940s and the 1970s. slight recession while experiencing some level of persistent inflation. This could mean that the markets continue their upward trend until an official recession hits.

My July 2023 newsletter is out: https://t.co/gTH0nUyrU8

The topic focuses on fiscal dominance and how large debts and deficits can mitigate the impact of higher interest rates as a policy tool. pic.twitter.com/qmuzInyYjK

Lyn Alden (@LynAldenContact) July 2, 2023 The Fed’s inflation fight continues

The significant difference between the two periods involves rapid bank lending and large monetized budget deficits, which Alden says are the underlying drivers of inflation. The first happened in the 1970s when baby boomers started buying homes, while the second happened during World War II as a result of funding for the war effort.

The 2020s are more like the 1940s than the 1970s, but the Fed is running the monetary policy playbook of the 1970s. That could prove to be quite counterproductive. As Alden explains:

So, as the Federal Reserve raises rates, federal interest charges rise and the federal deficit ironically widens at a time when deficits were the primary cause of inflation in the first place. This might be akin to trying to put out a kitchen grease fire with water, which is intuitive but doesn’t work as expected.

In other words, today’s inflation was primarily driven by the creation of new federal debt, or what some might call the government printing money.

Raising interest rates to calm inflation can work, but it’s aimed at inflation that has its roots in a credit expansion tied to bank lending. While higher rates tame this inflation by making borrowing more expensive and therefore reducing the creation of private sector loans, they worsen budget deficits by increasing the amount of interest due on these debts. The federal debt now represents more than 100% of gross domestic product (GDP), up from just 30% in the 1970s.

Federal government interest payment expenditures relative to the effective federal funds rate. Source: Fred

While the Federal Reserve has cooled parts of the economy by raising rates by 500 basis points in just over a year, the underlying cause of the current inflationary environment remains unaddressed. And with a debt-to-GDP ratio much higher than that of the United States 50 years ago, the situation will only worsen at a faster rate. But markets remained resilient, including tech stocks and crypto, even as the correlation between the two broke down.

In this way, the Fed may be using an inappropriate tool for the situation, but that hasn’t stopped the markets, at least for now.

Big Tech defies recession estimates and boosts stocks

Despite the Fed’s battle with inflation and market participants’ expectations of an inevitable recession, the first half of 2023 has been quite bullish for stocks, with the rally extending into July. As bonds sold off again, pushing yields to near-2022 highs, risky assets like tech stocks soared.

Importantly, this rally was primarily led by just seven stocks, including names like Nvidia, Apple, Amazon, and Google. These stocks constitute a disproportionate weight of the Nasdaq:

Just seven stocks make up 55% of the NASDAQ 100 and 27% of the S&P 500

The distribution has become so lopsided that the NASDAQ will rebalance to give less weight to these megacaps.

Source: @GoldmanSachs pic.twitter.com/k1xM1wmL2S

Markets and Mayhem (@Mayhem4Markets) July 13, 2023

Related:Bitcoin mining stocks outperform BTC in 2023, but on-chain data points to potential stall

Leaps Down, Crypto and Tech Up

The tech rally, driven in large part by hype focused on artificial intelligence and a handful of mega-cap stocks, was also helped by an easing in bond market liquidity.

Alden notes how it started late last year:

But some things started to change at the start of the fourth quarter of 2022. The US Treasury started to inject liquidity into the market and offset the Fed’s quantitative tightening, and the dollar index fell. The S&P 500 bottomed out and began to stabilize. Liquidity in sovereign bond markets has started to decline. Various liquidity-focused assets like bitcoin rallied.

A July 11 report from Pantera Capital makes similar observations, noting that real interest rates also have a very different story to tell compared to the 1970s.

Traditional markets may struggle, and blockchain could be a safe haven, in part because [t]The Fed must continue to raise rates, given that real rates remain at -0.35%, according to the report. The report also concludes that there are still tons of risk in bonds.

The report goes on to note that while most other asset classes are interest rate sensitive, crypto is not. Bitcoin’s correlation to equities in 2022 has been driven by the collapse of over-leveraged centralized entities. Today, this correlation has reached levels close to zero:

Bitcoin correlation with S&P 500. Source: Pantera Capital

One of the main takeaways may be that risk assets seem to have supply under them at the moment. However, this trend could easily be reversed by the end of the year.

Dan Morehead of Pantera Capital said it well when he said:

After trading 35 years of market cycles, I have learned that there is so long ago that markets can be down. Investors can only take so much pain. [] It’s been a full year since TerraLUNA/SBF/etc. It’s been enough time. We can rally now. Bitcoin price trend and year-over-year returns. Source: Pantera Capital

With the halving around the corner and the prospect of a Bitcoin exchange-traded fund on the horizon, crypto catalysts look poised to make a breakthrough in almost any situation.

This article does not contain investment advice or recommendations. Every investment and trading move involves risk, and readers should conduct their own research when making a decision.

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