Was the Fed Right About the Bitcoin-Macro Disconnect?
- By Bilal Hafeez and Dalvir Mandara
- Sign-up to discuss on Slack
- 2 min read
Macro
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- We expect the Federal Reserve (Fed) to hike 25bp in March (alongside consensus).
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- January PCE confirms disinflation is more fiction than fact.
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Summary
Trading View (next 2-4 weeks): We like to be bullish bitcoin.
Investment View (next 1-3 years): We like to be long bitcoin.
Macro
- We expect the Federal Reserve (Fed) to hike 25bp in March (alongside consensus).
- January PCE confirms disinflation is more fiction than fact.
- The probability of a recession within the next 12 months remains high.
- The macro backdrop is marginally bearish but could worsen if the Fed hike by 50bp in March.
On-Chain/Flow Signals
- Five bullish signals and one neutral.
- The on-chain signal is very bullish.
Overall View
- With the macro backdrop remaining a touch bearish, and our on-chain/flow signals remaining bullish, our overall view remains net-bullish bitcoin (Chart 1).
Macro: Is There a Bitcoin-Macro Disconnect?
A new Federal Reserve Bank of New York paper investigated the link between bitcoin and macroeconomic fundamentals, considering 2017-2022 data (when bitcoin ‘reached a more mature stage’). As Sam wrote in his Deep Dive on the paper, it found that news about policy rates and the economy hardly influence bitcoin’s intraday price movements. We propose an alternative angle, concentrating on a daily timeframe, not intraday. Moreover, we split our data into two periods:
- Pre-Covid Hiking: 2017 – 15 March 2022 (when the Federal Reserve first hiked),
- Covid Hiking: 16 March 2022 – 27 February 2023.
To test the relationship, we consider the relationship between bitcoin and rates, FX and equities.
The Relationship Between Bitcoin and Rates
Rates have come back into the meaning of macro. The correlation between rates and bitcoin has increased since the Fed first hiked the Fed funds rate, stronger than in the five years proceeding (Charts 2 and 3). However, they fail to explain the daily changes in bitcoin. Though, we note, it is better to follow real interest rates rather than nominal equivalents (Charts 4 and 5).
The Relationship Between Bitcoin and FX
The correlation between FX weakened since the Fed began hiking (Chart 7). However, it is explaining more of the variance within bitcoin’s daily changes – albeit to a significant extent (Chart 8).
The Relationship Between Bitcoin and Equities
Bitcoin is largely described as a risk asset. Therefore, it is no surprise that daily changes in the S&P 500 better explain daily changes in the price of bitcoin than the (small) pool of other assets we considered, despite a weaker correlation than others (Charts 9 and 10). This attribute has intensified since the Fed began hiking.
Macro Backdrop: The Macro Backdrop is Worsening
Last week’s US PCE shook markets. Proving hotter-than-expected, and accelerating across most categories of goods and services, a selloff in US bonds followed as markets added to their expectations for the Fed.
Going forward, Dominique continues to expect a 25bp hike in March. In her mind, a 50bp hike only becomes possible with another bumper non-farm payrolls (10 March) release. As it stands, markets are pricing c.30bps for the next two meetings and close to 75bp more of hikes.
Further afield, she continues to expect the Fed will have no choice but to hike the FFR to near 8%. As a result, John is maintaining a defensive equity portfolio.
On-Chain/Flow: ETF Inflows Resume
Five metrics give a bullish signal this week:
- Liquidity demand: exchange inflows have returned.
- Futures activity: perpetual funding rates remain positive while the future option interest has continued to climb.
- HODLer behaviour: older coins have stopped shifting as of late.
- P&L of investors: the percentage of circulating supply in profit has remained north of 70%.
- Mining activity: the hash rate and miner revenues are trending higher.
The remaining metric gives a neutral signal:
- Institutional demand: flows have been relatively light as of late. Little has changed there.
On balance, on-chain/flow metrics are giving a very bullish signal. Here are the details of each metric (with explanations in the Appendix).
Institutional Demand: Neutral Bitcoin
Our preferred metric to track institutional demand is flows into bitcoin ETFs. They were small through H2, relative to 2021, and this trend has continued in 2023. So, while there are inflows, they are unlikely to be price changing (Chart 11). This is neutral bitcoin.
Demand for Liquidity and Exchange Activity: Bullish Bitcoin
On exchange flows:
- Short term, there has been little bias for inflows or outflows (Chart 12).
- Longer term, the 30-day change in the exchange balance reveals fluctuations in the supply held on exchanges month on month. This metric has remained positive for the 12 of the past 14 days (Chart 13)
We view these metrics as bullish for bitcoin.
Futures Activity: Bullish Bitcoin
Futures open interest ($8bn), a good measure of investor interest, is up 10% over the past two weeks (Chart 14). Perpetual funding rates have pulled back sharply over the past two weeks but have remained positive (Chart 15). Together, this is bullish bitcoin.
HODLers: Bullish Bitcoin
On HODLer metrics:
- The 30-day moving average of the coin days destroyed (CDD) metrics is down 13% over the past two weeks (Chart 16).
- The 30-day moving average of the 1y+ revived supply metric is down 17% over the past two weeks (Chart 17).
- The 1y+ vintage dominates around 67% of the coin supply now (Chart 18).
Older coins have stopped shifting as of late, as shown by decreases in the CDD and the 1y+ revived supply. It leaves over 67% of the overall supply as over a year old, a comfortable majority.
Overall, we see the strong conviction to hold by most of the coin supply as a bullish signal for bitcoin.
Investor Profit and Loss: Bullish Bitcoin
On profitability of the coin supply:
- The percentage of circulating supply in profit (PSIP) has remained north of 70% (Chart 19).
- Similarly, while net unrealised profit/loss (NUPL) is down in the short-term, it remains high in comparison to the past six months (Chart 20).
- Year to date, the spent output profit ratio (SOPR) has started the year with a roughly equal number of days above one (realised profits) and below one (realised losses), with no clear bias for either (Chart 21).
The profitability of the coin supply is increasing, and the supply is again in an (unrealised) net profit position (NUPL > 0) whilst realised profits/losses on chain are equal in frequency. Overall, this is bullish for bitcoin.
Mining Activity: Bullish Bitcoin
The has rate has continued to trend higher, up 17% over the past two weeks (Chart 22). Meanwhile, miner revenues are up 10% over the period as miners reap the benefits of the broader crypto rally (Chart 23). Together, this is bullish bitcoin.
Appendix
Institutional Demand
Perhaps the largest institutional vehicle for bitcoin is the Grayscale Trust, with over $27bn in assets. It invests solely in BTC, and so many investors, notably institutional, who cannot hold BTC directly can get exposure through investing in Grayscale. Consequently, if the trust trades at a premium to BTC prices, it may imply ‘excess’ demand from institutions, but ‘excess’ supply if it trades at a discount. Alternatively, the discount may suggest investors have found other ways to get exposure to BTC, whether through ETFs or directly holding BTC. We therefore focus on how the discount has changed in recent months to gauge investor interest. Alternatively, investors may be using other vehicles to get exposure such as ETFs or holding BTC directly. We put more weight on BTC flows than the Grayscale premium.
Liquidity Demand
Another measure of cryptocurrency bullishness is whether investors are willing to hold it in illiquid form (e.g., a private wallet) or prefer a liquid form (e.g., on an exchange). The former would suggest investors are bullish, as they are comfortable with being unable to sell easily. Conversely, holding it in liquid form would suggest investors are bearish, as they prefer being able to sell easily.
Therefore, large flows onto crypto exchanges would suggest investors want to convert their holdings to a more liquid form, implying more bearishness.
Futures Activity
We track the growing market of bitcoin futures. Open interest – the sum of long and short contracts – is a good measure of investor interest.
Perpetual funding rates reveal the directional bias of investors. Exchanges set funding rates to prevent a lasting divergence in the price of the futures contract and the underlying since perpetual contracts have no expiry date so never settle in the traditional sense. Consequently, we can interpret funding rates as the cost of holding bitcoin via perpetual futures. Positive funding rates imply longs pay shorts and vice versa. We use it as a proxy for trader sentiment since a positive funding rate implies traders are paying a premium to keep open long positions.
HODLers
In our introductory bitcoin flow framework, we explained ‘HODLers’ and ‘HODLing.’ HODLing refers to buy-and-hold strategies in the context of bitcoin and other cryptocurrencies. Those who HODL for extended periods are die-hard adherents.
We can categorise HODLers by the length of time they have held BTC. We define long-term or staunch HODLers as those who bought BTC five or more years ago and have held it ever since, medium-term HODLers as those who bought 6-12 months ago, and short-term HODLers as those who bought 3-6 months ago.
The coin days destroyed (CDD) metric is defined as the number of coins in a transaction multiplied by the number of days since the coins were last spent. So, increasing CDD suggests older coins are being spent (more coin days are destroyed) and vice-versa.
Profit and Loss
The percent supply in profit (PSIP). This tracks the share of circulating BTC supply in profit. That is the percentage of circulating BTC whose current price is higher than when it was last transacted (movement).
Net unrealized profit and loss (NUPL). This is the ratio of unrealised profits over total market capitalisation. While PSIP just focuses on whether BTC coins are in profit or not, the NUPL focuses on the size of profits. So, we could have a situation where the PSIP is low – that is, a low share of supply is in profit – but the NUPL could be high if the size of those profits is large.
Spent output profit ratio (SOPR). While PSIP and NUPL focus on unrealised profits or mark-to-market, this measure focuses on realised profits. SOPR is the realised value of a transaction divided by the value at initiation (or creation) – more simply, price sold divided by price paid. If SOPR is above one, investors in aggregate have realised profits, while below one means they have realised losses. In broad uptrends, SOPR spends a significant amount of time above one, whereas the opposite is true for broad downtrends.
When SOPR is rising, sellers are increasingly realising profits. The opposite is true when it is falling. A price rally with a flatter SOPR trend indicates investors are not yet realising their profits with the rally. The reluctance of investors to sell and realise a profit may be because they believe the price will increase further, which would be bullish. At the same time, more profit taking could precede a correction. Typically, buying as SOPR moves around one during bullish periods has proven to be a profitable strategy.
Mining Activity
Computing power is central to the crypto market. Miners use advanced computing hardware to solve complex problems that confirm BTC (and other coins) transactions on the public ledger or blockchain. The miners are rewarded with new coins for their efforts. A measure of the complexity of the problems and so the computing performance required to solve them is the hash rate. The higher this rate, the more computing performance is needed to maintain the blockchain. The rate can fluctuate depending on demand for crypto.