Ecoinometrics - Inflation worries

September 15, 2021

Let me just check something in the dictionary real quick.

Transitory (adjective)

Continuing for only a short time.

Synonyms: fleeting, temporary.

Right, so I guess that doesn't really apply to inflation then...

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Inflation worries

One more month of CPI data and one more month of high inflation. I mean if you are reading those lines this is probably not a surprise for you. 

But apparently if you are an economist at the US Federal Reserve it is kind of unexpected. 

That or they forgot to check the definition of transitory.

Because so far this year the time series of headline inflation numbers looks like that:

  • August 5.2%

  • July 5.3%

  • June 5.3%

  • May 4.9%

  • April 4.2%

  • March 2.6%

That’s six consecutive months where inflation is above the 2% target set by the Fed. At some point you have to stop blaming everything on the base effect or the reopening and deal with the fact that this is getting sticky.

Because remember that inflation is a rate of change. That means even if it falls back down to 2% at some point, as long as it doesn’t go negative the price increases are there to stay (see this).

So the longer we stay in this “transitory” state of high inflation, the higher prices go with very little chance that they’ll actually come back down further down the line. 

And you know what? The general public is starting to get worried about that.

Every month the Federal Reserve Bank of New York conducts a survey to gauge the expectations of US consumers.

Among other things they are asked what is the inflation rate they expect to see one year from now. Guess what, consumers see inflation still above 5% next year…

If this prediction came to be true, that would be pushing people’s understanding of the word transitory to its limit… 

See for yourself.

There are two more interesting things you can see on this chart.

First, US consumers do not expect that their earnings will be able to keep up with inflation. Their guess is that a year from now they will earn 2.5% more than today. It would need to be twice as much to maintain a balance with price increases.

So you can imagine that people are getting worried that their real purchasing power is falling behind.

Which brings us to the second observation. Since last year already you can see that consumers expect the price of gold to rise to match inflation.

Obviously that hasn’t panned out yet. But it kind of shows that since people don’t think their wage can keep up with inflation, they are going to have to invest in store of value assets.

The New York Fed doesn’t ask where people think Bitcoin will be a year from now. But you can see where I’m going with that.

This data is for US consumers, but the same trend is playing out all over the world.

The longer this “transitory” period of inflation lasts, the more people are worried about their purchasing power and the more they are going to want to invest in assets that help them stay ahead of the curve.

In an environment where the real yield is at record low levels and gold is not doing anything, that leaves you with only a short list of assets people are likely to pile in.

Tl;dr this is good for Bitcoin.

CME Bitcoin Derivatives

Bitcoin made new all-time highs earlier this year. Then traders started to take profit and lose interest until finally we got some big correction. 

In retrospect there were some signs:

  • The on-chain participation to the accumulation trend dipped in the blue in April.

  • The open interest on the CME started declining at the beginning of the year.

  • Retail traders on the CME started to unwind their long positions in January.

None of this alone triggered the dip, but it made for easier conditions that made it possible to happen.

Since then I’ve tried to keep my eyes open for these early signs that could show how the sentiment is shifting.

And I thought we had spotted some signals on the CME BTC derivatives. But actually so far it remains inconclusive. 

Let’s have a look.

In the past retail traders as a group have been the most bullish on Bitcoin. So are they showing new signs that they are back in business?

Well not really. A couple of weeks ago I thought that was the case. But if you look at the net amount of long positions held by the retail crowd it is still stuck at the 2020 baseline. That is 50% lower than at the peak in January.

That’s not bearish. But they haven’t hopped back on the trend either.

The smart money is a bit harder to read. Overwhelmingly they have been chasing the basis trade arbitrage. This is not a directional position which means we can’t really use it to know what they think about the trend. 

That being said, nothing has changed for them in the past few weeks either.

And overall, if we judge things purely in terms of trading activity, it isn’t clear that the trend of declining open interest and average daily volume has bottomed yet.

Even looking at the CME Bitcoin options market you can tell that the sentiment hasn’t changed back to euphoria mode.

I mean, do you see the amount of blue in the chart below? Most of the action that’s close to the money is happening on the puts.

So I don’t know if we are going to see the sentiment on the CME derivatives leading or lagging spot BTC. But it is definitely worth keeping an eye on that to gauge the mood in the market.

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