Why is crypto following stock market closer than ever before?

It feels like nothing but the words of Jerome Powell matter in markets right now.

In looking at the data, it’s kind of true. I plotted the correlation of Bitcoin against the S&P 500 since the beginning of 2017, and the results show that the correlation has generally picked up over time. This really does shoot down talk of the “inflation hedge” narrative that proved so popular during the pandemic.  

But should correlations not come down over time? Well, not really. Think back to 2017, and the texture of the crypto landscape. It was still a niche asset; it was only beginning to get covered in the mainstream – and certainly nowhere near the level of digital ink that is spilled over it these days.

Today, we have public companies holding it. I took a visit to El Salvador this summer, where I paid for goods with it. These are remarkable developments compared to just a few years ago. Point being, Bitcoin is now in the mainstream.

And being a mainstream financial asset – and one that is substantially further out on the risk spectrum – it will indeed be influenced by the market.

2022

Indeed, this correlation has hit all-time highs this year, moving in lockstep with the stock market. What was the upward shift caused by? The interest rate environment has transformed entirely.

Following a decade of historically low interest rates, inflation has burst out at the seams as a result of incessant money printing and stimulus spending through the pandemic. In order to rein this in, central banks have been forced to hike, with the Federal Reserve in the US leading the charge.

Nothing sucks liquidity out of a market more than rising interest rates, and this is particularly true for high risk assets, such as tech stocks, which discount cash flows back to the present – discount rates which are now measurably higher.

And so – and this is something that is frequently overlooked – Bitcoin is now in a bear market while the wider market is too. Because for the first time in its existence, Bitcoin is experiencing a macro climate not awash with quantitative easing, basement-level interest rates and bullish sentiment. And it’s creaking at the knees – just like every other financial asset is.

Correlations rise in crises. Sellers are indiscriminate when a flight to quality occurs; liquidity is sought, defensive positions are taken and cash reserves rise. Bitcoin, for the first time in its history, is experiencing that the hard way.

In this context, it is no surprise that the correlation has risen.