Interesting Times

A few months ago the markets were confident we were approaching the end of big interest rate hikes and that after the summer central banks such as the US Federal Reserve would begin to ease their monetary policy. However, due to persistently high inflation, especially core inflation, the markets have adjusted their view which goes some way to explaining the recent crypto market volatility.

As cryptocurrency is touted as an inflation hedge and an alternative form of money, users are often confused or surprised to discover that over the short term it reacts in the same way the stock market does. This is mainly due to the low liquidity in the crypto market and the fact that it’s still very early in the overall lifespan of the technology.

Bitcoin was first released in January 2009, whereas Ethereum was released in July 2015. As well as still being extremely early in its development, crypto has never been through market conditions resembling those that we’re experiencing today.

Although policymakers want to be seen as being in control and confident, the reality is that they’re facing a combination of unprecedented situations which they have no idea how to solve. For instance, to survive the lockdowns vast swathes of money was printed and handed out to businesses and individuals.

The lockdowns stopped supply chains from functioning meanwhile people were at home with extra time and money. This combination proved disastrous for inflation, causing prices to skyrocket, and a deluge of job vacancies to appear when businesses restarted. To try and counter this, central banks began to raise interest rates in the hope that it would deprive businesses of money to fund new jobs and dissuade people from buying things on credit.

The specific aim of central banks is to slow money creation by private banks, increase unemployment, and plunge their economies into recession. This self-inflicted harm may appear counterproductive, but they see it as the lesser of two evils. Out-of-control inflation can easily devastate an economy and cause a far more catastrophic collapse than a short recession.

Their main difficulty however is that while they’re increasing interest rates they’re also faced with increasing energy costs due to sanctions imposed on Russia. To combat this many governments are simultaneously tightening monetary policy at the same time as easing it. Ironically both measures are aimed at reducing inflation but they’re leading to widespread confusion in the markets as to what the overall outcome of these conflicting policies will be.

In the US for instance, to keep soaring fuel costs down President Biden has been releasing 1 million barrels of fuel a day from the Strategic Petroleum Reserve, which is now at its lowest level since December 1984. This is due to end at the start of October and prices will inevitably increase, leading to higher inflation.

In the UK, the government is imposing price caps on the wholesale cost of energy to prevent consumers and businesses from financial ruin. The only way they can achieve this is to print more money to pay for the difference between their cap and the true market cost of the energy being used.

A similar approach has been announced by the EU which has allocated $278 billion to be used to achieve price caps, pay suppliers to keep costs down, or even as direct payments to the public to help them with rising bills. If the solution is simply printing money without solving the supply side issues it will invariably lead to higher inflation.

It’s very difficult for economists to see a way out of the present inflation problem when taking all these factors into account. As a result, markets are likely to remain risk-off for the next few months. Most commentators now believe it will be Spring 2023 at the very earliest before we start to see central banks stop or begin to reverse their interest rate hikes.

What this means for the crypto markets is that volatility is likely to continue for the next few months. The good news is that this may not result in significantly lower values for tokens. It may be that we continue to chop sideways with occasional dramatic ups and downs. The bad news is that the crypto winter still has a while to go before we can enjoy the excitement of the next bull run.

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  • Source: Plato Data Intelligence: