The latest trend investors are following is called reflation trade. Bitcoin is seemingly getting caught by the wave of investors looking for reflation trade opportunities, analysts claim. This article will explore:
- What is a reflation trade?
- How do reflation trades impact Bitcoin prices?
What is a reflation trade?
Reflation trades intend to profit from a simultaneous increase in economic output (REcovery) and prices (inFLATION). In theory, reflation trades work particularly well in an early recovery phase after a recession. During that phase, economic growth and prices pick up significantly.
Investors start buying industrial commodities and currencies linked to them, while selling bonds, thereby driving bond yields higher. Declining risk aversion also contributes to rising bond yields. At the same time, inflation concerns often arise, central banks tighten monetary policy and issue government bonds. As the pandemic subsides, pent-up demand for goods and services will lead to a large catch-up effect. Likewise, a rise in bond yields can be observed. US 10-year bond yields have risen from 0.7% in 2020 to over 1.1% in summer 2021.
Reflation trade, Bitcoin, and how the two are connected
Investors are hunting for a good reflation trade. Bitcoin has decreased from an April peak of $64,000. How do these two go together?
This effect results from reflation trades coming to an end. Traders started reflation trades after March 2020 in the wake of monetary and fiscal stimulus that promised a V-shaped recovery in economic activity and inflation. This was especially visible after the US presidential election when both Bitcoin and commodity-driven currencies strengthened. The Australian Dollar, strongly correlated with global commodity prices, appreciated from 72 to 84 against the Japanese Yen between November 2020 and March 2021. Bitcoin ripped from $10,000 to a high of $64,000 in April 2021.
However, as monetary policy tightening looms and appetites for risk diminish, so does a trader’s wish for a reflation trade. Bitcoin has felt the pain with a 50% retrace from its April high. Investors are wary of betting even more money on ballooning equity prices to hedge against inflation, and risky short-term assets like Bitcoin are first to feel the pain.
The end of the reflation trade – Bitcoin to plummet?
Bitcoin is similar to gold since it sold off during the March 2020 crisis, although it should be a safe haven for investors. The question is whether the end of the reflation trade leads to more pain for Bitcoin, which would mean BTC is perceived as a risky speculative asset.
On the other hand, if Bitcoin’s price was to recover and consolidate around its highs or even higher, this would indicate that investors have started considering Bitcoin a hedge against inflation and are putting their money where their mouths are.
Of course, inflation isn’t the only factor driving the Bitcoin price. Still, Bitcoin’s price action decoupling from other risky assets would elevate Bitcoin to safe haven status, or at least suggest it is on its way there. This would likely lead to further adoption of Bitcoin as a store of value by institutions and governments alike.