Crypto Markets Analysis: Inflation Cools, but Hopes for Fed Pivot Might Be Too Hot

The bitcoin (BTC) market is suddenly at its hottest in two months, after a five-day winning streak that has pushed the cryptocurrency’s price toward levels – breaching $19,000 on Thursday – where it traded prior to the epic market collapse that followed the implosion of Sam Bankman-Fried’s FTX exchange.

Crypto traders may want to exercise caution: The latest U.S. inflation reading suggests that Federal Reserve monetary tightening – among the biggest broad-market factors that put downward pressure on BTC last year – may still have a long way to go.

The consumer price index data for December shows inflation rose 6.5% from 12 months earlier, in line with expectations and down from a pace of 7.1% in November.

This marks the sixth consecutive month of declines in the inflation rate, and with it the sixth consecutive month of renewed hopes for a Fed pivot to lowering interest rates. The data suggests that little will change in the Fed’s approach.

While the overall inflation rate fell, much of the decline was concentrated within the energy sector. Energy services declined 17% month over month, while gasoline prices fell 9.4% over the same time period.

Prices for food, apparel and shelter were up 0.3%, 0.5%, and 0.8%, respectively, month over month and 10%, 2.9%, and 7.5% annually.

Bitcoin and ether (ETH) responded positively on the release of the data, with prices fluctuating as the day progressed.

BTC’s hourly chart shows a sharp uptick in trading volume during the hour of the announcement. Most telling in that hour of trading is the momentary decline in prices, implying that some traders viewed the inflation data as an opportunity to take profits.

ETH’s hourly chart shows almost identical price behavior, with a slight increase upon release of the report, followed by a price decline in the following hour.

BTC and ETH are up 5.5% and 2.8% overall on the day.

Probabilities that the Fed will raise interest rates by 25 basis points in February rose to 96% from 77% a day prior. Verbally this could be categorized as a shift from highly likely … to really, highly likely. Traders are reducing their bets on a more aggressive hike of 50 basis points.

But the federal funds futures curve implies that interest rates will increase to near 5% before pivoting lower in the second or third quarter of 2023. This remains largely unchanged – a sign that while the Fed might slow the pace of hikes, it will stay in hiking mode for quite a while.

Finally, while much of Thursday’s discussion has revolved around inflation, initial jobless claims for the week ending Jan. 7 fell below expectations. Lest we forget Federal Reserve Chair Jerome Powell's remark during a press conference after the central bank's last meeting that the jobs market “remains extremely tight.”

"Reducing inflation is likely to require a sustained period of below-trend growth and some softening of labor market conditions," Powell said at the Dec. 14 meeting.

Today’s data, while positive, shows that price increases are indeed cooling – but have further to cool. Expectations that the Federal Reserve will change its course of action – and pivot anytime soon toward softer monetary policy – should probably cool as well.