Will equities follow bitcoin and silver?
In a short period of time, the prices of bitcoin and silver, measured from their peaks, have almost halved. The question is whether this is a precursor to a major decline in equity markets. To assess this, we first look at the key drivers behind the sharp price increases—and subsequent declines—in bitcoin and silver.
From the day he was elected, Trump repeatedly stated that he considered the Federal Reserve’s interest rates far too high. In his view, the central bank should cut rates as quickly as possible. He even went a step further: according to Trump, the Federal Reserve—formally independent from politics—should ultimately fall under the authority of the president.
This must be seen against the backdrop of U.S. government debt now exceeding 100% of the overall economy, while the budget deficit is expected to remain around 6% of gross domestic product for many years to come. This implies that, unless interest rates move toward 0%, interest expenses will consume an ever-growing share of government spending. Expenditures that are essential for future economic growth are therefore increasingly crowded out, creating a negative spiral for the economy.
The only institution capable of addressing this is the Federal Reserve. It can finance an ever larger portion of the deficit with money it creates itself. This, however, leads to sharply rising inflation. Over time, the economy becomes constrained under such a regime, but historically this outcome has occurred in virtually all comparable situations.
It is therefore understandable that, following Trump’s remarks, markets began to price in a return to this type of policy sooner or later. Bitcoin and precious metals are the obvious hedges in such an environment. The same applies to many equities. In addition, massive investment is currently flowing into everything related to artificial intelligence, driven by expectations of a highly profitable future.
As a result, not only bitcoin and precious metals were bought, but equities as well. In precious metals, rising geopolitical tensions provided an additional tailwind.
As this dynamic persisted, investors worldwide increasingly felt they were “leaving money on the table” by not participating. This led to ever more aggressive price increases. Forced short covering also played a role. Charts began to show an almost vertical rise, pricing in an increasingly favorable future: more money creation by central banks and escalating geopolitical tensions.
While it is possible that policy will indeed move back in that direction over time, if this happens to a lesser extent than was priced in during the vertical rise, prices will eventually decline. For that to occur, however, a catalyst is required.
This time, that catalyst came from two directions. Politically, resistance grew against Trump’s attempts to undermine the Federal Reserve’s independence and force interest rates lower. In addition, Trump nominated Kevin Warsh rather than a fully loyal chair. While Warsh also supports lower rates, he wants to base them on expected productivity growth and inflation. Given his track record as an “inflation fighter,” markets assume that he would quickly adjust policy if those expectations fail to materialize.
Investors suddenly realized they had been assuming an overly accommodative future monetary policy and began taking profits. In equities, this was compounded by the possibility that expectations for continuously rising profits driven by artificial intelligence had become too optimistic.
Following the initial profit-taking, a process also began in which collateral values fell too sharply, forcing investors to compete with one another in (forced) selling.
What happens next?
It is quite possible that markets now overshoot to the downside and fall too far. The subsequent trajectory will depend entirely on future monetary policy. The key question is whether markets resume their upward trend after this “shake-out” or remain at significantly lower levels for the time being.
Markets currently assume that the adoption of artificial intelligence will reduce labor costs and inflation. This would give the Federal Reserve room to cut rates further later in the year, which would be positive for gold, silver, bitcoin, and equities. Under that scenario, a substantial rally could re-emerge relatively quickly. The underlying issue of high government deficits and debt would still persist, albeit to a lesser extent than previously priced in.
We, however, expect much more limited productivity growth and, at least until the elections in November, relatively strong economic growth. This would put upward pressure on wages and inflation. As a result, we expect interest rates to decline only marginally and to come under upward pressure again later in the year.
In that case, we expect gold, silver, and bitcoin to show limited upside for the time being and to remain, on balance, at relatively low levels. Only over the longer term might these markets regain momentum.
If interest rates do not fall further and later rise instead, we expect equity prices to be more likely to decline than to continue rising. A very sharp decline, however, appears unlikely in the near term, as the Federal Reserve is not expected to pursue restrictive policy for now. We only anticipate that later this year.
