Explaining the disconnect between Bitcoin and Treasury yields following US inflation data

Risky assets such as bitcoin (BTC) and the tech-heavy Nasdaq index gave unexpectedly positive performance on Tuesday, even as US consumer price index (CPI) data revived concerns about the hawkish Federal Reserve (Fed) and sent Treasury yields higher.

A rise in bond yields is making it more expensive to borrow and prompting traders to ditch risky assets in favor of fixed-income securities, as seen in 2022. Still, while the 10-year U.S. Treasury yield jumped more than 12 basis points to its highest in over a month, rising bitcoin nearly 2% on Tuesday, topping $22,000, and the Nasdaq ended the day 0.7% higher.

US CPI data showed that inflation in January eased slightly from the previous month, but the cooling trend moderated. The data also lifted the two-year yield to a two-month high of 4.64% and prompted traders to raise bets on a Fed rate hike of a quarter point (25 basis points) in June, while they assumed similar moves in March and May.

The central bank raised interest rates by 25 basis points last month, after delivering a half-point rate hike in December and four 75 basis point hikes earlier in 2022. The rapid tightening cycle saw risk assets, including cryptocurrencies, fall last year.

“Risk assets are implicitly tracking volatility, which sold off sharply after the CPI release,” QCP Capital’s market insights team told CoinDesk. “[We] guess the thinking is that as long as the Fed doesn’t panic and go back to 50 basis points, we’re in for a slow ride, which stocks can handle, especially if there’s a period of strong growth with high prices that will continue to benefit stocks through higher earnings.”

Implied volatility refers to the options market’s forecast of price turbulence over a specific period and is often equated with uncertainty.

Data from Amberdata shows bitcoin’s seven-day implied volatility fell sharply to an annualized 40% from 50% after the CPI release, paving the way for the cryptocurrency to track tech stocks higher.

Also, while inflation remains stubbornly high, the economy remains robust, giving risk assets a reason to rally. Goldman Sachs CEO David Solomon said on Tuesday that the outlook for a softer landing for the US economy had improved. Soft landing means a cyclical decline in economic activity that stops just short of an outright recession, as measured by successive quarterly contractions in the growth rate.

According to Singapore-based QCP, bitcoin’s resilience could be volatile, especially if “it starts to look like the Fed will raise the median dot plot at the March meeting.” In December, the median dot projected a rate at the end of 2023 of 5.125%.

Noelle Acheson, the author of the popular newsletter Crypto is Macro Now, said bitcoin’s resilience stems from declining broader market volatility and its positive impact on liquidity conditions.

“Among risk assets, crypto is the purest of the liquidity plays,” Acheson told CoinDesk in a Telegram chat. “Liquidity is not only dependent on lower interest rates, it is also affected by factors such as volatility (lower volatility tends to reduce collateral requirements, and both the VIX and MOVE bond volatility indices are on the decline) and oil prices (a lower consumption of energy frees up more liquidity).”

Unlike stocks, cryptocurrencies don’t have to worry about earnings downgrades, nor will they be hit by a wave of bond issuance and the resulting increase in yields, Acheson said.

Griffin Ardern, a volatility trader at crypto asset management firm Blofin, said market maker action lifted bitcoin higher after the CPI data.

Market makers are individuals or entities with a contractual obligation to maintain a healthy level of liquidity on an exchange. They are usually on the opposite side of investors’ trades and maintain a delta-neutral (directional neutral) book that requires active management.

According to Ardern, investors had bought BTC put options, or bearish bets, ahead of the CPI release, meaning market makers were selling puts and selling bitcoin in the spot/futures market to hedge against the risk of a price crash. Then, after prices started to rise after the CPI, market makers had to buy back the sold bitcoin.

“That drove prices up further,” Ardern told CoinDesk.

Bitcoin was trading above $22,200 at press time.