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Key Takeaways
Falling real yields push investors out of cash and into risk assets potentially like crypto.
Bitcoin rallies tend to align with declining or negative real yields
Chart of the week: US 2-year real yields vs Bitcoin
In the past two years, markets have been shaped by sentiment and headlines, significantly influencing the decision to hold assets like crypto.
Wars, tariffs, elections, and disruption of supply chains have created enormous noise. This week I wanted to share a perspective, using facts and data, that may help you cut through it all.
This perspective is based on how markets think about risk assets relative to the cost of money. And by the end of this, give you insights on how to think the same way.
Or put another way, how can we measure where the bar is for the market to be incentivised to move out of cash now versus the past.
This will be a good one! Let’s dig in.
Real yields
There’s an economic concept called real yields. It takes the yield on a government bond and subtracts expected inflation. This is important because it draws a line in the sand of when it’s less attractive to hold money, because the amount of interest bonds are earning, isn’t keeping up with inflation.
If real yields are negative, your capital is technically losing value each day because inflation exceeds the interest you get from holding cash in the bank.
Now we can start talking about incentives. If real yields are negative, and a market is looking for ways to get a return on their capital, they simply are incentivised to take on risk in a variety of ways. Such as start or grow a business, invest in equities or corporate bonds. Maybe even invest a portion of their wealth into emerging markets like cryptocurrency.
When we apply this framework to markets and overlay Bitcoin’s price, it starts to come together.
Chart of the week: US 2-year real yields against Bitcoin
The blue line below represents real yields, and the orange line Bitcoin. What to take note of is when real yields are reading positive, reading negative as well as the trend direction.
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During the bull market of 2021(green arrow), we can see that real yields were negative. These were much deeper incentives for the market to take on risk than the most recent all-time high in 2023 (red arow).
This may offer a reason as to why we didn’t see an altseason. There wasn’t enough incentive for the market to step that far out on the risk curve. The market was still in positive real yields.
It’s also important to note that real yields have been declining since 2023, with the recent rise in crypto prices coinciding with a sharp drop in real yields.
So, the real thought experiment from here is what could influence real yields to move higher or lower from here? Because we can see how the incentive structure would change for people to buy Bitcoin or other crypto assets.
As a reminder, the logic for real yields is = US 2-year treasury yield minus 2 year inflation expectations. If front end interest rates fall, and/or inflation rises, this would cause real yields to fall. And when you think about it, both happening at the same time would be a goldilocks scenario. Real yields would likely fall and potentially even head towards negative.
The opposite scenario is also possible. If we see interest rates in the US rise in the near term, and/or inflation falls we could see more reasons for the market to be incentivised to stay in cash.
Pretty interesting hey! Hopefully this has given everyone another take on how to view the market holistically, beyond the headlines.
This is also the why behind why you’ll regularly read and hear me referring to why tracking changes in interest rates and inflation is so important right now.
See you next time.