Tick Tock…Stagflation Could Mean the End of Fiat

  • High inflation numbers forced the Federal Reserve to take a hawkish pivot.
  • The Fed’s actions will likely cause a recession and not sufficiently tackle inflation.
  • The risk of stagflation is rising fast.

Bitcoin’s correlation to the equity markets is reaching all-time highs. The equity markets continue to behave like a government-run asset bubble. They exhibit high levels of dependence on monetary policy. Every whisper from the Federal Reserve moves markets and the price of Bitcoin significantly. This past month continued to witness high volatility caused by the tense geopolitical and macroeconomic landscape.

As a result of the monetary action taken during the pandemic, the Federal Reserve trapped itself between high levels of inflation and the rising risk of a recession. Inflation was made worse by the Russian invasion of Ukraine, which sent energy prices soaring. This spike in energy prices had a ripple effect on the price of many other goods in the economy.

Last month, it seemed the Fed was going to try to engineer a “soft landing” by taking gradual, predictable action. The latest high inflation data, however, forced the Federal Reserve to take a hawkish pivot. The Fed’s preferred measure of prices, the personal consumption expenditures price index (PCE), rose to an annual rate of 6.4% in March, which was the highest increase since January 1982. On 12 April, the consumer price index (CPI) then showed an annual increase of 8.5%, which was the largest increase since December 1981.

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It is almost certain that balance-sheet runoffs and rate hikes will now occur faster and more aggressively than previously assumed. Markets are expecting a ~$100bn balance-sheet monthly runoff and increases of 50 bps at the May, June, and July meetings, which would bring rates to 2.5%-2.75% by the end of the year. These would be the most hawkish measures taken by the Federal Reserve in decades.

As the latest driver of inflation is the Russian invasion of Ukraine, however, it is unlikely that the Fed’s actions will do much to temper inflation. The Fed’s actions will thus only precipitate a recession and increase the risks of stagflation - economic stagnation coupled with high inflation.

Should the very unlikely scenario of a “soft landing” materialize (i.e. lower inflation and no recession), the equity markets and the price of Bitcoin are likely to recover significantly. A recession could also prove positive for markets if it leads to looser Fed policy. Faced with a crumbling economy, the Fed could stop its current trajectory and start to lower rates again and increase quantitative easing measures. Should it continue on its projected path of quantitative tightening and interest rate increases during a recession, however, this could prove painful to the equity markets and the price of Bitcoin.

A stagflationary situation would push the Fed to take extreme measures such as drastically increasing interest rates. In that scenario, it is also highly probable that the markets and the price of Bitcoin would take a severe hit. Ironically, however, the scale of such a crisis could push more people away from fiat and towards Bitcoin, as faith in fiat would plummet and an increasing number of people would come to resent macroeconomic mismanagement. Stagflation could expose the problems of fiat currencies to a wider audience, which would drive Bitcoin adoption.

In the interim, the situation will remain highly volatile for the equity markets and Bitcoin. Volatility will persist because news and data releases will trigger fear and euphoria in short succession as a result of the tense macroeconomic and geopolitical context. Going forward, the price of Bitcoin will likely depend on the actions of the Fed and what the markets expect the Fed to do. Any deviation, or perceived deviation, from expectations will move the price of Bitcoin substantially. As always, the tense macroeconomic and geopolitical situation can change any parameters significantly and at very short notice.

Nothing in this article constitutes professional and/or financial advice. The content is provided exclusively for informational and/or educational purposes. Nothing is to be construed as an offer or a recommendation to buy or sell any type of asset. Seek independent professional advice in regards to financial, tax, legal and other matters.

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