Bitcoin waits for guidance from US inflation data, bond market

With the supply overhang from Germany's Saxony state nearly cleared, Thursday's release of the U.S. consumer price index (CPI) report will be pivotal in determining the bitcoin (BTC) market's trajectory.

The data due at 12:30 UTC (8:30 ET) is expected to show the cost of living in the world's largest economy rose 0.1% month over month in June after remaining flat in May, leading to a 3.1% rise year over year, according to economists surveyed by Dow Jones. The core CPI, which strips out more volatile food and energy prices, is forecast to have increased 0.2% from May and 3.4% since June last year.

If the actual figure matches estimates, it would confirm continued progress toward the Federal Reserve's (Fed) 2% inflation target and set the stage for the bank to begin the much-anticipated rate cut cycle this year.

Increased prospects of rate cuts will likely bode well for risk assets, including bitcoin, helping the leading cryptocurrency extend its price recovery from the July 5 lows of around $53,500. CoinDesk data show that the recovery has stalled, with buyers struggling to establish a foothold above the $59,000 mark.

"CPI data will be closely watched, with markets expected to react significantly to this release. Analysts' optimistic outlook for late 2024 and 2025 hinges on the FOMC reducing policy rates, as lower rates typically increase liquidity, driving investors towards 'longer-tail' assets like cryptocurrencies," algorithmic trading firm Wintermute told CoinDesk in an email.

The inflation rate has slowed dramatically from the high of 9.1% in 2022. Still, in recent months, the Fed has reiterated the need to see further progress on the inflation front before pulling the plug on elevated interest rates. On Tuesday, Fed chief Jerome Powell said the same in his testimony to Congress, while stressing the bank won't wait for inflation to cool to 2% to cut rates.

According to the CME's FedWatch tool, since Friday's weak payrolls report, traders have priced about a 70% chance of a Fed rate cut in September and see a rising probability of another cut in December.

Focus on bonds

The U.S. Treasury yield curve's response to the expected soft CPI release might influence the broader market sentiment, including bitcoin.

Slower inflation and increased rate cut bets can boost prices for the two-year note, sending its yield lower. That's because when investors foresee lower interest rates, they are willing to pay a premium for a security with a higher yield in the present. Meanwhile, the yield on the 10-year note will likely stay elevated as markets fear bigger budget deficits under the potential Trump presidency. Republican candidate Donald Trump's odds of winning the Nov. 4 elections have recently increased.

The net effect will be a so-called bull steepening of the yield curve, represented by the spread between yields on the 10- and two-year notes. The curve has been inverted, with two-year notes consistently offering a relatively higher yield since mid-2022.

According to the CAIA Association, periods of bull steepening, characterizing a fast normalization of an inverted yield curve, have historically occurred during periods of economic contraction and coincided with risk aversion.

"Typical bull-steepening periods were: 1990-1992, 2001, 2003, 2008 and 2020, and all were recessionary periods," CAIA said in an explainer.

"Equities typically do not fare well during this type of regime, and their performance during these times clearly lags the overall historical average," CAIA added.

Noelle Acheson, the author of the Crypto Is Macro Now newsletter, made a similar observation in the July 4 edition, saying, "a sharp steepening has always preceded the beginning of a recession."

Acheson added that the curve has recently steepened somewhat due to lingering political uncertainty in the U.S. "It also makes a Trump victory more likely in the interim, which implies a possible inflation uptick driven by tariffs and a flood of issuance to fund the promised tax cuts," Acheson explained.

Investment banks like JPMorgan and Citi are betting on the steepening of the yield curve.

The green shaded area represents U.S. economic recessions. (Noelle Acheson, TradingView) (Noelle Acheson, TradingView)