The Path to Recession: Understanding Yield Curve and What It Means for Bitcoin
In the world of finance, predicting the future is always a challenging task, but understanding the signs that the market sends us is crucial. In this article, we will delve into the world of yield curve inversions, explain why yield curve uninversion is so important, and analyze what the uninversion of the yield curve means, and ultimately what it could potentially mean for Bitcoin.
Understanding Curve Inversion
First things first, let’s talk about yield curve inversions. This is when the longer-term yields come down below the shorter-term yields. It’s like when the tortoise passes the hare in a race. But in the financial world, this means trouble. It’s a red flag waving in the face of the economy, saying “hey, something’s not right here!”
And when that yield curve inverts, it’s highly likely a recession is coming. That’s because the market is saying the policy rate today is too high. The growth expectation in the future doesn’t match where the policy rate is today, so the policy rate is too high. And history has shown us that an inverted yield curve leads to a recession within one to three years.
After that curve inverts, it has to uninvert. It’s like when you take a tight knot and slowly loosen it. And that’s what we’re seeing right now, folks. The curve is re-steepening, and that’s a good thing.
It means interest rate cuts are on the horizon. And that’s important, because the curve only uninverts when rate cuts are coming. It’s like seeing the finish line and getting a second wind while running a marathon. That’s what interest rate cuts do for the economy.
What Happens Next?
When the ten-year yield falls below the two-year yield, it signals that the policy rate is too high for the future growth expectations. This is what we call an inverted yield curve, and historically, it has always preceded a recession within one to three years.
But what happens after the curve inverts? Well, it has to uninvert, and that’s what we’re seeing right now with a re-steepening of the curve. This bull steepening occurs when all yields are falling while the curve takes on a steeper shape.
Now, you might be wondering why the curve uninverts in the first place. It’s because the market expects interest rate cuts to come through. When the two-year yield is higher than the ten-year yield, it’s a sign that the policy rate is too restrictive. The curve only uninverts when the market expects rate cuts to bring the policy rate down from where it is today. This is not a mere pause or rate hike, we’re talking actual rate cuts.
What Does All of This Mean for Bitcoin?
You might not be surprised to hear this, but there are two opposite outcomes for Bitcoin. First, the bad news. In times of credit contraction, stocks tend to perform poorly. And with Bitcoin’s high correlation to the stock market over the last year, it’s too early to tell whether Bitcoin will weather the storm of a stock market bear market. This means that in the short term, we could see Bitcoin’s price decline along with the stock market.
But there is some good news, too. Bitcoin is correlated with global liquidity, which means that an increase in liquidity from the Fed could potentially benefit Bitcoin in the long term. And while the correlation between Bitcoin and stocks has been high in the past, it’s currently declining. This means that Bitcoin may be able to survive a stock market downturn and even potentially decouple from the stock market in the future.
That said, it’s important to note that this is all speculation at this point. We simply don’t know how Bitcoin will perform in a credit contraction scenario, as we haven’t seen one play out during Bitcoin’s existence. All we do know is that Bitcoin was born out of a similar scenario to what we have now and was made for this.