Bitcoin price stumbles amid investor aversion to risky assets, but there is a silver lining

The US stock market is approaching a crucial turning point as uncertainty surrounding inflation increases following warmer-than-expected economic data released in February. Despite growing investor concerns, the economy is showing signs of resilience that could protect against a significant downside move.

The escalating risk-off sentiment in the market is also creating volatility for Bitcoin (BTC). The leading crypto asset, which has had a strong correlation with the US stock market, moved opposite to the stock market in February. The correction between BTC and Nasdaq turned negative for the first time in two years. But with the crypto bulls stalling at the $25,200 level, the risk of a downside is rising along with stocks.

While there is certainly reason to be cautious until the release of new economic data and the US Federal Reserve meeting in March, some indicators suggest that the worst may yet be over in terms of new market lows.

Inflation remains sticky

The biggest concerns in the current bear cycle, which began in 2022, have been decade-high inflation. In January, the consumer price inflation (CPI) level was warmer than expected, with an increase of 0.2% compared to the previous month.

There are some additional signs that inflation may remain sticky. Inflation in the housing sector, which accounts for more than 40% of the weight in the CPI calculation, has shown no signs of abating.

The market appears to be sliding back to the 2022 trend where rising inflation equates to higher Fed rate hikes and poor liquidity conditions. The market’s expectation of an interest rate increase of 50 basis points in the upcoming meeting on 22 March has increased from single-digit percentages to 30%. Fed President Neel Kashkari also raised concerns that there is a lack of signs that Fed rate hikes are dampening service sector inflation.

However, a report by Charles Edwards, founder of Capriole Investments, argues that inflation has been on a downward trend with a minor setback in January, which is not decisive.

“Until we see this chart plateau, or increase, the inflation risk is overstated and the market has so far overreacted.”

The release of the February CPI on March 12 will be instrumental in creating market bias in the short term.

Edwards says recession risk is lower than ever

Despite high inflation levels, the risk of recession in the stock markets has reduced considerably. Edwards noted in the report that the jobs sector remains robust with low unemployment levels, which is striking, especially in the “late end of the cycle.” He added,

“Ultra-low unemployment combined with high interest rates increases the chances of an unemployment bottom in (or forming).”

But the market is also more sensitive to rising unemployment from here. If unemployment levels respond to the Fed’s hawkishness, a decline in the stock market due to recession risk could quickly increase. February’s job sector report will be published on 10 March.

According to the report, the worst declines in the S&P 500 over the past 50 years when similar fears of recession were widespread have been -21%, -27% and -20%. The recent 2022 low also marked the 27% decline mark, which is encouraging for buyers. That raises the possibility that the bottom for the S&P 500 may be in.

Currently, the S&P 500 and the technology-heavy Nasdaq-100 index are threatening to break below their 200-day moving averages of 3,900 and 11,900 points, respectively. That raises the possibility that the surge in late 2022 and early 2023 may have been another bear market rally rather than the start of accumulation with the bottom mark for this cycle. A move below the 200-day MA for the stock market will add further pressure to the crypto market.

In December in particular, when the stock market rallied higher, crypto markets remained flat due to the aftermath of the FTX collapse. In early 2023, the crypto markets probably played catch-up with the stock market, and at the moment they may be experiencing the end of the opposite reaction.

Related: Bitcoin on-chain data highlights important similarities between 2019 and 2023 BTC price rally

A possible bear trap?

As the Fed prepares for renewed hawkishness, it puts more pressure on the upcoming debt limit crisis for the US Treasury. Since mid-2022, when the Fed began quantitative easing, the US Treasury Department has been facilitating backdoor liquidity injections. However, the extra liquidity from the treasury will be completely drained by June 2023.

The market’s optimism earlier this year was probably from the fact that the Fed would start cutting interest rates at the time Treasury funds dried up. However, if inflationary support goes up again and the Fed continues to raise interest rates. By June, the economy will be in a precarious position with expensive credit and limited liquidity from the treasury.

Still, as Edwards mentioned, “there’s no question of risk in the market,” but the economy is in a much healthier position than expected. The probability of a recession is down to 20% from 40% in December. The current weakness may be a bear trap until feelings improve again. Much will depend on the release of economic data this month and price action around key support levels.

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