Bitcoin’s price movements—especially in recent years—are often tied to macroeconomic events, such as injections of liquidity by central banks and governments. In this article, I explore whether the correlation between BTC and stocks is still worth paying attention to.
Key takeaways
- Bitcoin’s correlation with stocks has weakened over the past few months, perhaps signalling that it is maturing as an asset.
- Whenever a central bank’s balance sheet grows, monetary debasement occurs.
- Monetary debasement is not inflation but can lead to it.
- BTC continues to be correlated to monetary debasement.
Bitcoin & The Stock Market
Historically, the correlation between Bitcoin (BTC) and U.S. stocks strengthens during times of uncertainty and volatility. For instance, BTC and the S&P 500 index moved in tandem during the COVID-19-induced crash in early 2020.
This correlation then weakened through the rest of 2020 and into 2021. After BTC hit record highs in Nov. 2021, this correlation strengthened as both asset classes plummeted. In fact, Bitcoin moved in lockstep with the Nasdaq 100 for a vast portion of 2022.
Year to date, the story has changed again. BTC is up 74%, significantly outperforming the S&P 500 (+14%) and Nasdaq (+5%).
Some analysts believe the fading correlation with the S&P 500 is good for BTC’s price. They think that as BTC de-correlates from traditional markets, it could become a more attractive asset for investors looking to diversify their portfolios.
This change is largely welcomed for Bitcoin as it would help establish it as a distinct and maturing asset class rather than a speculative investment subject to the same market forces as stocks.
Similarly, eToro’s trading platform articles show that the tight correlation with Nasdaq 100 had materially fallen, where the correlation coefficient dropped from 0.3 in January to 0.17 in February.
Risk assets tend to fall first and fall the hardest during market downturns. It was observed in the 2022 downturn, where tech stocks and crypto led the way down. Conversely, Bitcoin’s recent decoupling from tech stocks signifies the potential shift in people’s perception of Bitcoin. Some argue it has become a safe-haven asset.
Banking Crisis
The recent collapse of U.S. banks and Credit Suisse has blindsided most people, including Federal Reserve Chair Jerome Powell, who commented only 2 weeks prior that the banking system was sound. It has brought on a stimulus that forms the first stage of the expected Fed pivot.
The problem started when rates were at historic lows. To find yield, banks decided to buy long-dated treasuries. This locked away the banks’ liquid funds. As the Fed went on the fastest hiking cycle in U.S. history, the value of the Treasuries fell.
If the banks could hold these to expiration (i.e. held to maturity), there would be no loss, but the asset’s long-dated nature meant that the Treasuries’ market value had fallen. As customers started withdrawing from banks such as Silicon Valley Bank (SVB), it forced them to sell more Treasuries at a loss. Eventually, the losses led to a bank run that ultimately closed the bank. Banking is a confidence game. Without it, the financial system collapses.
The next to come was the threat of financial contagion. Contagion happens during financial unrest. Global financial markets are highly interconnected, so the fears of more bank failures can cause further bank runs. It translates to an increase in credit risk worldwide.
This matters immensely to Bitcoin because the banking failures have thrown the asset class into the limelight as a genuine alternative to the existing financial system. Some see the need to hold a small portion of their wealth in BTC because they have realised that their bank deposits do not belong to them.
If there is no money printing to backstop the collapse of small- and mid-tier banks, the failing bank will be unable to return any uninsured deposits. The depositors will have to wait in line for the sale of assets, such as property loan portfolios, to recoup their hard-earned money.
Fed Balance Sheet Increase
The U.S. Fed has spent the past year decreasing its balance sheet by $700 billion. Within one week, the Fed’s balance sheet increased by $297 billion during mid-March 2023. That is nearly half of the past year’s efforts wiped out in a week.
Some argue this isn’t typical quantitative easing (QE) because most of the expansion came from banks borrowing short-term loans to manage the impending crisis. They argued that QE relates to monetary purposes, but this is about financial stability. While this may be technically correct, the reality is that any increase to the Fed’s balance sheet goes towards monetary debasement.
Monetary debasement is the reduction in the value of a currency. This is not the same as inflation, but it may cause inflation.
Take the following example: There is an island with 100 x $1 notes. When you debase the currency by creating another 100 of these $1 notes, you have reduced the dollar’s value by half. Inflation on food won’t necessarily double because the island has land, building, metals and other assets to buy. That is why people have historically used gold as the ultimate hedge against debasement.
For this reason, it doesn’t matter what the purpose of the balance sheet increase is. What matters is that it is increasing. Additionally, one must not forget the massive U.S. debt that requires servicing. The only way it can be serviced is through money printing, which pushes monetary debasement forward.
Up To $2 Trillion of Liquidity is to Be Injected
Further to the banking crisis, up to $2 trillion of liquidity may be injected into the U.S. economy to backstop bank stability. Under the Bank Term Funding Program (BTFP), the Fed has created a new bank lending arrangement that acts as a form of monetary easing. $2 trillion is only a tiny portion of the banking system’s value, so if a bank run eventuates, it remains to be seen whether this is enough.
While some have stated that the enormity of the backstop package will ensure confidence in the banking system, it is merely a colossal band-aid. The source of the problem has not been addressed, and that is the elevated Treasury yields compared to bank deposit yields. If the Treasury yields continue to rise, people will naturally be incentivised to take their money out of banks for higher returns.
As the U.S. does not have a spare $2 trillion on standby, it must print more money. Irrespective of what the monopoly money is spent on, it is impossible to inject that much into the financial system and not have it impact asset prices.
Steve Donzé @steve_donze
Deputy head of investment & Quattro fund manager at Pictet Asset Management Japan. “Lags in effect” of global liquidity. LSE PhD alum.
Impact of Monetary Debasement
One potential impact is increased demand for hard assets like gold and BTC. The demand could come from individuals through to institutions wanting a haven to protect the value of their dollar. The balance sheet injection could also increase demand for risk assets, such as stocks and cryptocurrencies.
It could lead to further decoupling of BTC and other cryptocurrencies from traditional assets like stocks as they become increasingly viewed as distinct asset classes with unique investment opportunities and risks.
One key thing to note is that the U.S. is not the only injector of liquidity into its financial system. In January and early February, China and Japan drove global liquidity expansion. This saw risk assets perform well during this period.
Towards the back half of February, these countries took their feet off the peddle and risk assets retraced. After confirming the U.S. Fed’s injections, the markets rebounded strongly. Once again showcasing the influence of global liquidity on risk assets.
So, What Is Bitcoin Correlated To?
Bitcoin’s correlation to the U.S. stock market, and even to the tech sector, has declined in recent times. At least currently, it seems to track movement in global liquidity more closely.
Another way of looking at this is when there is substantial monetary debasement, BTC will do well and lead the rest of the asset classes. This was observed through the liquidity injections from Asia in January and February and the banking backstops of the U.S. in March. Bitcoin’s price movements have been governed by it. Perhaps this is Bitcoin front-running the pivots of central banks worldwide.
Further to Bitcoin’s value during monetary debasement, below are charts showing BTC priced in Venezuelan bolivars (VEF) and Argentine pesos (ARS). Since November, BTC/VEF and BTC/ARS are nearly 500% and 100% higher, respectively.
One-year price charts for BTC/VEF and BTC/ARS (Source: XE)
In summary, Bitcoin typically moves in harmony with monetary debasement. This has been the case in terms of month-over-month (MoM) and year-over-year (YoY). BTC has risen faster than the amount of money printing, but it also drops substantially more when debasement takes a break.
Recap
BTC’s correlation with stocks has weakened in recent months. Some have attributed this to Bitcoin’s maturing as an asset class, while for others, it’s more so because of the recent U.S. bank collapses. While most arguments are valid, the one indisputable point is that BTC has moved in tandem with activities that create monetary debasement. I don’t expect this trend to change any time soon.
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