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December 4, 2020

Weekly Market Wrap

Why Bitcoin’s price has not quite caught up to its real value even after hitting a new all-time high

An almost endless list or reasons keeps appearing for Bitcoin to rise in value, yet the spot price of the largest digital asset is seemingly lagging behind virtually every other indicator even as the real value of the US Dollar continues to fall.

Yes, Bitcoin has recently rallied to a new all time high, and it has also attracted the interest of a number of high-profile firms such as Guggenheim and Skybridge; the former filed an amendment with the U.S. Securities and Exchange Commission to allow its $5 billion Macro Opportunities Fund gain exposure to Bitcoin via the Grayscale Bitcoin Trust (GBTC). Alongside that, the co-head of the portfolio strategy team at Bernstein Research, Fraser Jenkins, said the “significant reduction” in the volatility of bitcoin’s price makes it more attractive both as a store of value and as a medium of exchange.

However, given the growing correlation to equity markets and recent propensity to trade like a risk asset, there are questions over whether it can conform to its initial notion as a non-correlated asset and act as a hedge against inflation. Still, that hasn’t stopped its most avid supporter, Microstrategy CEO Michael Saylor, from going against the tide of measured shareholder responsibilities and going all in on Bitcoin. He was quoted as saying that “what we’re trying to do is preserve our treasury. The purchasing power of cash is debasing rapidly”.

At first glance, it would appear that the recent price action by the USD supports the aforementioned concerns. The USD index continues to head south and has now dropped to a level last seen in April 2018. So, is inflation spiralling out of control and is the monetary policy in complete disarray, or is this a cyclical event that will come to pass?

It is true that market measures of US inflation expectations have steadily climbed. In fact, one particular measure derived from Treasury Inflation-Protected Securities (TIPS), the 10-year “break-even” rate, this week hit its highest level since May 2019, and now sits at 1.87 percent. That may seem high but this compares to a current inflation rate of 1.4 percent recorded by Core CPE. Also, the central bank has a target for Core CPE of two percent which it has persistently failed to meet. Based on this, the central bank is yet to have anything material to worry about.

It is also worth remembering that the COVID-19 pandemic of 2020 has pushed the Federal Reserve to rewrite the rule book and its approach to its “dual mandate” of price stability and maximum sustainable employment. This new approach has seen the Fed put more onus on bolstering the US labor market and less on worries about too-high inflation.

Federal Reserve Chair Jerome Powell acknowledged earlier this year that declines in unemployment in the past led to concerns about rising inflation and prompted the Fed to raise interest rates, but that does not mean the Fed will do that now. Said otherwise, new policy framework will promote higher inflation to spur economic recovery and job creation. Again, this would suggest that concerns about inflation are yet to be warranted.

The fact that US lawmakers are yet to finalise a much anticipated (and needed) stimulus package has not helped to support the USD and, given the election fraud claims by the outgoing President Donald Trump, has in turn led to the crisis of confidence. It is also worth remembering that the EUR accounts for around 57 percent of the USD index and thus plays a crucial role in determining the overall price action. On that note, EUR/USD has hit the highest since April 2019, and a level well above the 1.2000 which European Central Bank (ECB) economist noted was a line in the sand in early September, when the central bank was uncomfortable with the strengthening Euro.

Daisuke Karakama, chief market strategist at Japanese bank Mizuho, suggested that the euro’s recent gains have been fueled by the view that the European Central Bank “has run out of policy tools”. The main supporting factor for the Euro’s strength is the region’s large trade surplus, which reflects real demand for the currency, and this stands out in a zero-rate world. As a result, only aggressive, potentially spot currency intervention, is likely to check the euro’s surge – especially when compared against the Dollar.

Given the growing institutionalisation of digital assets markets, as evidenced by the climbing use of CME futures and options, ad the impending launch of the S&P Dow Jones crypto index announced earlier this week, it would stand to reason that macro developments will play a larger role in how digital assets and, in particular, Bitcoin reacts to liquidity events, be that structural liquidity shortage, or capital injections by central bankers.

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