Cryptos had sold off on prospects for tighter global liquidity as central banks pare pandemic-related relief measures. Yet the market appears to be recovering as central banks prime investors for tighter liquidity and higher interest rates.
The Bank of England raised interest rates on Thursday—the first major central bank to do so. The Federal Reserve said on Wednesday that it anticipates three rate increases in 2022, following a wind-down of its bond purchases.
The Fed’s announcement triggered a rally in stocks, though the market was giving up some of those gains on Thursday, with the Nasdaq Composite index falling 2% in afternoon trading.
One interpretation of crypto’s relative strength is that fears of a “taper tantrum” were already priced in, sparking a rally as the Fed’s outlook didn’t contain any surprises.
“This speaks to the idea that a taper tantrum is not the straw the breaks crypto’s back,” Fundstrat Global Advisors wrote in a note on Thursday. Bitcoin withstood five interest rate increases in 2017 as it rallied from under $1,000 to $19,000, Fundstrat noted. “We think this at least signals that rate increases won’t be the starting gun of any prolonged bear market,” Fundstrat says.
Prices in futures markets implied that Bitcoin and Ether had been oversold, according to J.P. Morgan.
“Momentum decay has been hitting both Bitcoin and Ethereum in recent weeks,” J.P. Morgan’s global market strategy team wrote in a note on Thursday. Short and long-term momentum has been “downshifting” over the past month and now stands near oversold levels of last May and June.
Bitcoin and Ether futures have fallen into “backwardation,” meaning that spot prices have moved slightly above futures prices. That is a bearish signal, implying that investors are willing to pay more for a commodity today than they would for delivery in the future. The opposite situation, called “contango,” is when futures prices trade above the spot.
“When demand is particularly weak and price expectations turn bearish, the futures curve shifts into backwardation,” says J.P. Morgan. The last time Bitcoin and Ether futures shifted to backwardation was in May and June, they note. Prices stayed weak through the summer and then rallied in October.
The selling pressure now may be coming from big momentum traders in the futures markets such as commodity trading advisors, or CTAs, says J.P. Morgan. Moreover, investors can earn 10% yields on stablecoins—tokens designed to maintain a fixed $1 value—providing a high “risk-free” rate that may be more attractive than returns in Bitcoin or Ether futures.
Still, the opportunity costs of sticking with cash are going up as rates increase. Whether cryptos can hold on to gains amid pressure on other high-risk assets, as those costs rise, remains to be seen.
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