Inflation slowing down is hope for BTC bulls

Key points:

S&P500 tends to bottom out when the CPI peaks.
Bitcoin has more or less moved in tandem with the U.S. stock market.
The 2018-to-date CPI trend in the U.S. is similar to the ebb and flow of the early 1970s, implying that a further slowdown in inflation and a rebound in risk assets may be on the horizon.
Many investment banks and financial commentators have suggested on Twitter that the continued decline in risk assets in the first half of this year will force the Fed to abandon monetary tightening.
The Fed, aware of the premature liquidity easing in 1975 and the subsequent sharp rebound in inflation, is unlikely to abandon its tightening policy and will choose to cut interest rates in the foreseeable future. This will dampen potential returns on risky assets.

For risky assets, including cryptocurrencies, the question of whether inflation has peaked is acceptable.

Inflation has moderated in the U.S. and the rest of the world since the third quarter of 2022. In response, the world's most powerful central bank, the Federal Reserve, has eased the liquidity crunch that has propelled cryptocurrency stocks into a bear market over the past year.

The question now is whether the turnaround will be enough to raise risky assets.

The answer is yes, according to data showing that the S&P 500, the benchmark for Wall Street stocks and global risk assets, tends to bottom out when the consumer price index (CPI) peaks. Historically, Bitcoin has more or less moved in tandem with the U.S. stock market.

The U.S. CPI appears to be following the early 1970s analog

This chart from Steno Research and Macrobond compares the trajectory of the US CPI from 2018 to the present to its trajectory from 1972 to 1984, adding the trajectory of the S&P 500 in the 1970s.

The index bottomed out in late 1974, when CPI was at its peak, and then rose more than 50% over the next 21 months. A similar pattern emerged after the second peak in the CPI in March 1980.

The 2018-to-date CPI trend in the U.S. is similar to the ebb and flow of the early 1970s, implying that a further slowdown in inflation and a rebound in risk assets may be on the horizon.

The 1972-1984 playbook shows how equities bounced right as the CPI peaked even as the earnings outlook deteriorated markedly at the same time. If the market sniffs out an inflation-driven pause or a pivot from the Fed, even before a drawdown in risk assets is seen, we may get a disinflation rally that will wrong-foot all investment banks.

Andreas Steno Larsen, founder, and CEO of Steno Research, said in a note published on Dec. 26, explaining reasons to begin 2023 with a bit of risk exposure.

Many investment banks and financial commentators have suggested on Twitter that the continued decline in risk assets in the first half of this year will force the Fed to abandon monetary tightening.

U.S. consumer inflation slowed to 7.7% in November 2022 from a 40-year high of 9.1% in June. The Fed reversed its 50 basis point hike in December after raising rates four times in a row by 75 basis points. However, the bank said rates would rise in a range of 5% to 5.25%.

Limited upside potential

Still, some observers remain cautious.

"The stagflation parallels of the 1970s suggest that while a slowdown in inflation is imminent, it is unlikely to hit the Fed's 2 percent target. Even more troubling, there is a risk of a V-shaped recovery if the Fed eases sooner," said the headquartered Singapore's QCP Capital said in its 2023 Market Unwrap Note.

"Concerns about the double-dip inflation seen in the 1970s and 1980s are deeply ingrained in the FOMC's psychology," the QCP said.

In other words, the Fed, aware of the premature liquidity easing in 1975 and the subsequent sharp rebound in inflation, is unlikely to abandon its tightening policy and will choose to cut interest rates in the foreseeable future. This will dampen potential returns on risky assets.

The chart shows inflation rebounded sharply in the latter half of the 1970s as the Fed eased prematurely in 1974-75. Source - TradingView