Right now the imminent threat to the global economy is the impact of spreading coronavirus. In the financial markets, there is another potential complication and risk forming: that market participants overestimate the likelihood that the Federal Reserve cuts interest rates due to the virus.
With bonds rallying and Fed funds futures traders pricing in an emergency cut or two by June, investors are playing a risky game assuming the Fed will respond to a biological force the same way as they did last year during the U.S./China trade war. If these cuts are priced in but do not actually come to fruition, just about every asset class apart from cyclical stocks will likely respond negatively. I believe Bitcoin has the potential to give investors the clearest message about the Fed's direction. The cryptocurrency has traded both as a risk and risk-off asset in the past, because both groups have been tied to the assumption of lower rates. But no asset class needs cuts more than Bitcoin.
Its entire story, if you really believe in its potential as a store of value, is as a controlled-supply alternative currency in a world where central bank extravagance has eroded away the buying power of fiat currencies. The deeper and more frivolous the Fed cuts are, the better its future looks. But since stocks really started getting hammered this week, Bitcoin has done very little, even as the implied odds of Fed cuts – a figure determined by bond market action – are soaring.
If bitcoin drops while those odds are climbing, it suggests Bitcoin’s hopes of being a store of value are getting squashed by risk-off sentiment. Or, it means Bitcoin is sniffing something out about the Fed that the bond market has not yet. I’m not sure which is more exciting.
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