Crypto’s macro drivers – it’s not just about Bitcoin

This week, to no one’s surprise, we saw another 25 basis point (bp) increase in the federal funds rate. The increase itself is not that significant – background noise, if you will. We are all used to this by now. What is remarkable about this one is that it is very likely to be the last. This is a very big deal for the entire crypto market, not just for bitcoin (BTC).

Below, I dive into why I think this week will be the last US rate hike, why this is good news for bitcoin, and why the tailwind extends to other cryptoassets as well.

Noelle Acheson is the former head of research at CoinDesk and Genesis Trading. This article is an excerpt from her Crypto is macro now newsletter, which focuses on the overlap between the changing crypto and macro landscape. These opinions are hers and nothing she writes should be taken as investment advice.

Last week, preliminary US GDP came in at 1.1% quarter-on-quarter growth, much lower than the 2.0% expected, and still lower than the fourth quarter’s downward revision of 2.6%. The bulk of the disappointment was due to weak inventory building, with defense and consumer spending accounting for most of what little growth there was. Adjusted for inflation, consumption rose by 3.7% in the 1st quarter, much higher than the previous quarter’s increase of 1.0%. Remember that this increase is after one of the steepest interest rate hike campaigns ever.

This is unfortunately reflected in inflation data. The Federal Reserve’s preferred index of personal consumption expenditures (PCE) inflation excluding food and energy (known as core PCE) for Q1 rose 4.9%, more than the consensus estimate of 4.7% and than Q4’s 4.4%. The more granular PCE reading for March, released on Friday, showed no eye-popping increase but didn’t fall either, coming in at a flat 0.3%, or 4.6% year-on-year. Again, frustrating resilience after nearly five percentage points of rate hikes in 12 months.

So because higher rates don’t seem to be working, does that mean the Fed needs to raise them even more? Not necessarily. As the Fed has often reminded us, the data moves with long and variable lags, with no guidance on what “long” means. There are signs that the acceleration in core prices seen in the 1st quarter is about to slow down. In addition to the March figure, we have the Cleveland Fed’s Inflation Nowcast, which models April core PCE steady at just over 4.6%. This could encourage the Fed to choose to wait and see if more impact begins to emerge, which it likely will.

Currently, this probability is not obvious. On Friday, we saw the employment cost index for the 1st quarter come in at a slight increase of 1.2% quarter over quarter. This is the Fed’s preferred employment cost measure because it takes into account benefits as well as wages and is therefore not distorted by employment shifts between occupations or industries. The increase was only 0.1 percentage point, but that it was there at all is worrying, and the year-on-year increase was 4.8%, well above the inflation target of 2%.

But there are signs that the labor market is cooling down. Thursday’s U.S. continued jobless claims held on to gains in early April, with the latest four readings up more than 6% from the previous four. The wave of layoffs depressing our headlines suggests this number is likely to continue to rise.

One thing that jumps out when you look at charts of the unemployment rate over time is that when it starts moving up, it happens suddenly and quickly. The tightening credit outlook will further limit economic growth as companies struggle to refinance, leading to even more layoffs, and the impact on demand will exacerbate the painful momentum.

I am aware of these trends and I think it is likely that the Fed will pause rate hikes at the June Federal Open Market Committee (FOMC) meeting and then hold steady for a while as higher interest rates begin to do the damage. We should not forget that reported economic data is retrospective. The US Conference Board’s leading economic index fell 1.2% in March, more than double the decline in February. This downward trend should continue as the effects of tighter bank credit roll through the economy, punctuated by damage to balance sheets from falling collateral values. Dark clouds are gathering.

If the Fed takes a break in June, this will be good for bitcoin as it implies an easing of economic conditions.

While interest rates themselves may not change, expectations of cuts on the fast-approaching horizon should be enough to move the liquidity needle – with the exception of the 1960s, an extended pause after a series of hikes has always been followed by cuts. Moreover, financial conditions are not only defined by the rate of fed funds: they are also influenced by bank profits and politics, the price of oil, the level of the dollar, fiscal policy and the credit outlook around the world, among other factors.

In fact, while the Chicago Fed’s national financial index — which looks at U.S. capital markets as well as shadow banking — shows a tighter environment than a couple of years ago, it is on the decline, which means more market liquidity.

This is important for bitcoin because it is one of the most sensitive assets to changes in aggregate liquidity. You no doubt often hear that “risk assets” benefit from looser economic conditions. Well, bitcoin is the ultimate “risk element” in that respect:

We can expect BTC to continue to act as a liquidity barometer, as it did in January and again in March, when the Fed’s interest rate policy has settled into wait-and-see mode. And liquidity is likely to increase when interest rates peak and as the looming recession becomes increasingly apparent.

While bitcoin is the most “macro” of all cryptoassets, the macro environment also affects other cryptoassets, in different ways.

Bitcoin remains the anchor of the crypto market, with an increasing dominance (percentage of total market capitalization) and a high correlation with other tokens. In other words, what happens to bitcoin affects the sentiment of the entire stock market cap chart.

It does so through increased attention to the entire ecosystem, which encourages new businesses as well as their funding. A rising BTC price justifies investment in market infrastructure and crypto-asset services, which in turn support access and liquidity to other assets. Where BTC goes, the market tends to follow.

Additionally, once funds are comfortable with an allocation to BTC, many will look for even higher return opportunities, meaning they step out on the risk curve. This tends to be encouraged by easing economic conditions, with potential gains more than offsetting the costs of leverage.

There is also the special case of ether (ETH), which is more directly affected by macro dividends. Currently, stakes on the Ethereum network earn about 5% in rewards, without taking into account any price increase. This is less attractive to macro investors when US Treasuries offer similar risk-free returns, but when these fall, the equation changes. Also, ETH’s relatively stable returns come with the potential for upside. Now that stakes are flexible after the recent Shapella upgrade, macro investors are more likely to consider ETH over other steady income opportunities, especially if it is seen as a window to greater ecosystem participation.

While the macroeconomic outlook and the likely path of monetary policy is at one of the most uncertain moments in recent history, stepping back to look at the entire investment landscape can reveal pockets of opportunity as well as highlight narratives that did not exist the last time the global economy was in a similar position. For the first time, we have assets that do not depend on considerations from the traditional economy for operations, and which contain a number of new use cases that in turn provide resilience to investment tasks.

All economic cycles have certain patterns that tend to repeat themselves – that’s one of the reasons they are called ‘cycles’. Crypto markets also have cycles, only these in the past have been mainly driven by crypto-specific factors. Not anymore – now the crypto market has multiple drivers, making the narratives more complex while opening up the market to new investment cohorts.

This should not only continue to close the gap between the crypto and macro landscape; it should also bring even more attention to cryptoassets’ unique properties.