​“Independence has evaporated.” How US inflation affects the crypto market

Inflation in the United States continues to slow down. From June’s highs of 9,2%, price growth fell to 7,7% in October. According to market analysts, weakening inflation potentially allows the US Federal Reserve System (Fed) to reduce the pace of key rate hikes.

The Fed’s key rate is now at 4%, its highest since 2007. Another rate hike, to 4,75%, is planned before the end of this year.

The Fed rate is the interest rate that regulates US monetary policy. If the rate rises, it makes conservative financial instruments such as debt securities or bank deposits more attractive. This leads to capital outflows from stock exchanges and negatively affects stock prices. With the Fed’s rate cut, the US stock market gets incentives for growth, and investors find it more profitable to invest in stocks and risky financial instruments, including cryptocurrencies.

According to a survey of Bloomberg analysts, next year is predicted to start a recession in the US economy. Experts admit that in such circumstances, the state will be forced to re-enter the financial influence in the economy to keep it from collapsing. Such a situation can become a trigger for further growth of inflation, which will be much more difficult to stop.

Inflation and the crypto market

US inflation and global stagflation impact the crypto sphere more indirectly than directly, explains Nikita Zuborev, senior analyst at Bestchange.ru. According to him, previously the inflating inflation was negatively affecting expectations for the US economy, which was depreciating the US dollar. Accordingly, not only other world currencies rose in value against the dollar, but also commodities, including cryptocurrencies, which occupy an intermediate position between these two categories.

Shortly before the FTX scandal, this even led to a revival of the cryptocurrency market, the analyst notes. The bitcoin (BTC) rate rose to a two-month high and could have continued its moderately positive local growth trajectory if not for other factors.

The growth or decrease in inflation affects the financial system as a whole and consequently, the cryptocurrency market, agrees Vladislav Utushkin, founder of TTM Group. If inflation increases, consumer prices rise and people’s purchasing power falls. Against this background, the depreciation of fiat currency and companies’ shares begins, thanks to which the crypto market should grow. “The idea is that cryptocurrencies help to keep money from inflation and in the long run earn money, under the right circumstances. However, this is no longer working as it used to. It’s all about the strengthened connection of the crypto market with the stock market,” the expert specifies.

What is the connection

That said, according to the analytics platform IntoTheBlock, digital assets have depegged from risky assets after the collapse of FTX. For example, the correlation between bitcoin and the S&P 500 stock market index turned negative on November 20 to -0,74. According to analysts, this suggests that the market of digital assets has ceased to respond to the dynamics of the dollar and stock indices. Previously, a similar situation was observed in December 2021.

The correlation between the cryptocurrency market and the stock market is explained by similar investor behavior rather than a direct economic relationship between the two, Zuborev explains. Investors sell and buy assets based on common strategies, so common cash flow vectors may coincide in different markets of similar risk-class assets. Shares and cryptocurrencies are risky investment instruments, so they react very vividly to any economic events, which makes it possible to notice coinciding trends.

However, it is worth noting that even 5 years ago the trends were rather opposite, and the money supply migrated from the stagnating stock market to the actively developing cryptocurrency market. “Today this difference has almost disappeared, but it is always worth considering this factor: the two markets compete with each other for capital,” the analyst adds.

Bitcoin, which affects all other cryptocurrencies, is closely correlated with the stock market, Utushkin explains. In his opinion, the correlation was formed due to the fact that more institutional investors came to the crypto market over time. Their investments are distributed across all types of assets, so when the S&P 500 or Nasdaq indices fall, bitcoin tends to fall after them. “Because of this, most smaller investors don’t look at cryptocurrencies as protection of their funds, for example, against the same inflation. The independence of cryptocurrencies from the traditional economy has evaporated,” concludes the founder of TTM Group.