Bitcoin Rallies to 2-Month High; What's Next?

Bitcoin (BTC) is rallying after Wednesday's U.S. economic data offered hope that rampant inflation might have peaked and that the Federal Reserve will slow liquidity tightening in the months ahead. According to some analysts, however, those hopes may be misplaced and those dreaming of a steady bull run may be disappointed.

The U.S. consumer price index surged 8.5% in July from a year ago, matching June's pace but falling below the average estimate of 8.7%, according to the economists surveyed by FactSet. Core inflation, which strips out food and energy prices, rose 5.9%, compared with expectations of a 6.1% increase.

Bitcoin has rallied 6.5% to $24,500 since the release of the CPI data. The cryptocurrency clocked a high of $24,744 during the early hours of Thursday, its highest price since June 13.

The dollar index, which tracks the greenback's value against major currencies, hit a five-week low of 104.64 on Wednesday and was at 105 at the time of this writing. Futures tied to the S&P 500 traded 0.33% higher, hinting at a continuation of Wednesday's rally.

Jean Boivin, head of the BlackRock Investment Institute, cautioned investors from chasing the rally as the core inflation provides the Fed little wiggle room.

"Looking through the past two CPI reports, core CPI is still running at an annualized 6% pace. We are still awaiting the Fed to acknowledge the trade-off: that crushing growth would be needed to get inflation back to 2%," Boivin said in a tweet thread published after the CPI release.

"We expect the Fed to pivot eventually, but the stickiness of core inflation tells us that the market has become overly optimistic on how soon the Fed might do so. That’s why we don’t think this bear market rally is one to chase and expect more volatility ahead," he added.

Griffin Ardern, a volatility trader at crypto asset management firm Blofin, said that "liquidity pressures are expected to ease in the far future, but certainly not now. And so, with liquidity pressures still mounting, the crypto market rally looks like a bull trap."

The Fed attempted to deliver that message to markets on Wednesday, with Minneapolis Fed President Neel Kashkari saying the central bank is "far, far away from declaring victory" on inflation. Kashkari said that he hadn't seen anything that could change the Fed's current strategy of raising rates to 3.9% by year end and 4.4% by the end of 2023. The benchmark rate is in the 2.25%-2.5% range, which means the Fed is only halfway through the rate cycle.

Noelle Acheson, head of market insights at Genesis Global Trading, shared a similar opinion, saying the core CPI appears stick and the so-called Fed pivot may be months away. "The data yesterday does not mean the Fed will ease up on rate hikes, not until they see a trend of core CPI moderation, which is probably months away," Acheson said.

Genesis Global is owned by Digital Currency Group, which also owns CoinDesk.

The Fed's balance sheet shrinkage, or quantitative tightening (QT), often referred to as the underappreciated but potent sister of rate hikes, seems to have fallen out of focus with market discussions centered around rate hikes.

The central bank is scheduled to accelerate QT to its maximum speed of $95 billion per month starting in September.

"Quantitative tightening is the elephant in the room and is set to accelerate three times from July’s rate to $90 billion per month in September," Lewis Harland, a researcher at Decentral Park Capital, told CoinDesk. "This is important as the rate of change in Fed balance sheet is correlated to the rate of change in crypto-asset prices."

Harland added that the QT might act as a fundamental macro headwind for risky assets later this year.

The recent recovery in crypto markets is at least, in part, fueled by the optimism about the Ethereum blockchain's long-awaited Merge. The supposedly bullish upgrade will likely happen next month and could shelter the crypto market from bearish macro factors.

"The stock market reaction [to CPI] felt more emotional than rational, but the crypto market reaction – while partly a relief bump – is also being driven by the predominance of crypto-specific narratives, such as the Merge as well as notable progress on some DeFi (decentralized finance) platforms," Acheson said.