NYDIG Research Weekly: The Yield Curve Is Not a Crystal Ball
by Greg Cipolaro, Global Head of Research and Ethan Kochav, Research Analyst
A weekly digest of Bitcoin news and insights.
IN TODAY'S ISSUE:
Yield Curve Inversion Says Little About Impending Recession
A few weeks ago, an important event occurred in traditional financial markets: the yield curve inverted. For historical context, the yield curve has been reasonably predictive of future economic activity and an inversion, when the longer dated obligations yield less than shorter dated obligations, has typically preceded economic recessions in the US. The part of the curve that inverted, though, 10Y Treasuries minus 2Y Treasuries, is a less commonly used measure of inversion. The spread that is more closely watched as a recessionary indicator is 10Y Treasuries minus 3M Treasuries. The 10Y minus 3M spread is what institutions such as the NY Fed use in their recession predictor here, and it is steepening, not inverting.
In addition to understanding the differences between the two yield curves, it is important that investors understand there have historically been long lead times between yield curve inversions and subsequent stock market peaks and wide variability on those time frames. The average time to stock market peak following the first 10Y-2Y or 10Y-3M inversion is over a year, and the standard deviation is over half a year.
While a recession most certainly will occur at some point in the future due to the cyclical nature of the economy, predicting or posturing for it is probably not a worthy endeavor, especially in the context of long-term holding, something we advocate for bitcoin.
The US Dollar Strength Might Gloss Over More Fundamental Macro Factors
US dollar strength, by measure of the US Dollar Index (DXY), has been blamed as one of the factors weighing on bitcoin returns year to date. Bitcoin’s correlation to the DXY, which had historically meandered about 0, has been stubbornly negative since mid-2020. The correlation as measured over the last two years using monthly returns is -0.22. This trend of bitcoin’s increasing correlations has been seen across various asset classes and factors, most notably equities. Bitcoin’s correlation to the dollar makes intuitive sense when looking at the price of bitcoin in dollars. The exchange rate between the two assets relies on both of their strengths and weaknesses, so the value of the dollar, even when measured against a basket of different currencies, should play a role in bitcoin’s dollar price. That said, bitcoin is by far the more volatile of the two currencies, as shown by the fact that, even since 2020, the DXY’s returns only explains 4.7% of bitcoin’s price movements. This is apparent when looking at a year-to-date price chart. Even though the two prices end up in opposite places, bitcoin’s price moves look fairly unaffected by those of DXY.
Also, looking at the dollar as a causal factor glosses over the drivers of the dollar itself, which are subtle and complex. In particular, the Fed’s desire to stamp out inflation may be a main factor. As the Fed has taken a hawkish posture, this has significantly raised interest rates. As inflation expectations have failed to outpace these interest rate increases, this means that real rates, which are equal to the nominal interest rate minus inflation rates, have increased. Other central banks have yet to take as hawkish an approach. Real rates effectively measure the carry value of a given currency, so this means that the dollar is becoming a relatively more valuable currency to hold, increasing the exchange rate versus other currencies. The same argument is true of the US dollar vs. bitcoin and other stores of value like gold: as it becomes more valuable to hold dollars, some investors may reallocate from bitcoin or gold to the dollar. Notably, real rates have long been a known driver of gold returns. Monthly changes in 10Y real rates and monthly returns of gold have had a correlation of -0.4 since 2011. Like the negative correlation of bitcoin to the dollar, the negative correlation of bitcoin to real rates has only emerged in the last couple of years. We still think bitcoin will largely be driven by factors fundamental to the asset itself, such as user growth and network usage, but it is also important to understand these evolving macro relationships.
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Treasury Sanctions its First Digital Mining Company
On Wednesday, the US Department of the Treasury’s Office of Foreign Assets Control (OFAC) announced sanctions against Russia-based crypto miner BitRiver. While not the first sanctions against Russia based-crypto organizations or individuals, the news was notable because the sanctions were the first resulting from Russia’s invasion of Ukraine. This is also the first time the US has sanctioned a crypto miner. Mining is a vehicle for Russia to monetize its natural resources without needing to export them from the country. OFAC considers Russia’s use of mining to be a form of sanctions evasion. One example of this is activity elsewhere is Iran, which has made heavy use of crypto mining to generate hard currency since sanctions have made it difficult to export its own oil production.
BitRiver reportedly has 300MW of capacity it operates on behalf of mining clients. It was reported that mining service provider Compass Mining, which had placed equipment at BitRiver facilities, promptly turned off machines there and was looking to sell the equipment, returning whatever capital was recoverable to existing clients. 300 MW represents less than 2% of the network’s estimated 15.92 GW of installed capacity, which if it went offline entirely would not likely result in any network disruption.
Market Update
Bitcoin increased this week by 3.6%. Stocks were mixed on the week, with S&P 500 flat and Nasdaq Composite down 1.3%. Gold fell by 1.3%. Bonds were mixed. Investment grade corporate bonds fell by 1.6%, high yield corporate bonds were down by 0.6%, and long-term Treasuries were flat. Real yields were mixed and inflation expectations increased.
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