Russia-Ukraine: What It Could Mean For Crypto

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The Russian invasion of Ukraine has hit global markets, including crypto assets, which have historically shown correlations to risk assets. This relationship has become even more pronounced in recent years as institutional investors have increased their presence in the crypto universe. As we wrote in our January 26th Market Byte (Macro Risks In-Focus, but Secular Growth Story Remains) and our February Newsletter, Fed monetary policy and geopolitics have continued to be primary drivers of crypto prices and market movements. While crypto markets experienced a ~25% rally following the January Fed meeting, the asset class has since retraced those gains with the broader risk asset sell off. Bitcoin has been especially resilient, rebounding from a 12% drop within 12 hours on news of Russia’s invasion of Ukraine. The near-term geopolitical situation continues to unfold and the market response remains fluid. Here, we’ll discuss some of the factors driving markets and what they could mean for crypto prices going forward.

 

Risk Assets Finding Support

 

Crypto assets (using BTC as proxy), U.S. Equities (S&P 500 Index), and Russian Equities (Russia Trading System or RTS Index) have roughly tracked each other during the beginning of 2022: All three markets rallied from late January to early February, then sold off over recent weeks as Russia escalated geopolitical tensions.

Source: Bloomberg, 1: RTS Index is a cap-weighted composite index of the largest and most liquid Russian stocks on the Moscow Exchange

Commodity Prices Near Highs But Starting To Reverse

 

Global commodity prices have increased over the past two years in response to the strong global economic recovery. This trend has accelerated over recent months as rising geopolitical tensions have amplified supply chain disruption concerns. Russia is the world’s third-largest producer of liquid petroleum, the second-largest producer of dry natural gas, and a major source of energy for Europe. Ukraine is the world’s fifth largest exporter of wheat.

Source: Bloomberg

Markets Re-evaluating Fed Rate Hike Expectations

 

Markets have priced in higher Fed rate hike expectations since last quarter, roughly around the time crypto markets peaked. Earlier this month, Fed Fund futures rose to price in nearly seven 25 basis point rate hikes during 2022 while pricing in a 50 basis point rate hike during the coming March meeting. However, the hawkish trend reversed over the last two weeks as investors have been evaluating Fed rate expectations given the rising geopolitical uncertainty.

Source: Bloomberg

VIX Elevated But Not Signaling Recession Panic

 

The CBOE Volatility Index (VIX) has become increasingly elevated over the last month and now sits at its highest level since early 2021.

Source: Bloomberg

Investor Sentiment At Extremely Bearish Levels

 

Investor sentiment has become increasingly negative over recent months and is approaching bearish levels that haven’t been seen since the early part of the pandemic.

Risk-Assets Bottoms During Past “Invasion” Events

 

During historical invasion events, risk assets (stocks) bottomed just before “invasion” five out of five times. The chart below (data courtesy of Fundstrat) shows equity markets six months prior (two months prior are shaded in gray) and 18 months after invasion events.

Source: Fundstrat

Long-Term Store of Value: Bitcoin vs. Gold

 

Bitcoin and gold prices have diverged during 2022 amid the ongoing macro and geopolitical turmoil. While Bitcoin is generally regarded as a high risk asset, the volatility may present good buying opportunities while the asset continues a long-term upward trend outpacing gold.

Source: Tradingview, Roshun Patel

Bullish & Bearish Cases Vs. Our View

 

There’s always reasons to be bullish and reasons to be bearish, but what matters most is which will outweigh the other, especially over the long term. While current macro conditions and geopolitical tensions have created a tough environment for markets, we think crypto investors focused on the long-term should see the recent volatility as an opportunity. Below are some reasons investors may have to be pessimistic and optimistic about crypto prices compared with our view:

 

 Bear CaseBull CaseOur View
Risk Market PricesMarkets continue to attempt to price in Putin’s next move. Even further escalation from Russia surprises markets and drives prices lower. Investors have already priced in the current invasion along with further Russian actions and prices may have bottomed. Bitcoin rallied from above the January 24th price low—which is encouraging. If prices can mount a further rally on a new “bad news event” in the coming days to weeks, it would give a further sign of seller exhaustion from the current crisis. 
Commodity PricesGeopolitical tensions have amplified global commodity price increases, which can contribute to inflation and increase Fed tightening risks. Energy and wheat prices are still at their highs and could be signaling additional geopolitical risks may be present. Supply chain risks may slow economic output and lead to stagflation. Commodities have started to turn lower over today which may indicate markets are less concerned about the conflict. While prices are near their highs, their inflation contribution could slow as year-over-year comparison becomes more favorable. Sanctions haven’t targeted Russian energy given strategic importance to the EU and the global economy. The conflict may give the Fed and current administration some political cover for the rising inflation. The Fed will watch the commodity price rise carefully, but we are not currently in the camp that it would lead to higher sustained inflation and require more aggressive policy action nor cause the economy to enter a period of stagflation. 
Fed ExpectationsFed rate hike risks are underpriced. The market was largely doing the Fed’s job by tightening financial conditions but the geopolitical-driven risk-off move into bonds has caused a retracement in rates. The Fed may feel the need to signal a more aggressive rate hike path to offset this which may further strain risk-assets. 

The Fed has more room to maneuver now. The conflict may be viewed as an added risk to the economic recovery that causes the Fed to take a more dovish reassess of their path. 

Policy makers may consider additional fiscal stimulus. Policymakers may view the conflict as justification for added fiscal stimulus. 

The Fed will continue to watch to see how the geopolitical situation unfolds and the markets reacts. Lower rate hike expectations may benefit risk assets and crypto, which prices may start to reflect as markets gain more certainty over the geopolitical situation.  
Elevated VIX The VIX is somewhat elevated but nowhere near panic levels that would be reflective of a recession. Russia’s invasion may cause second-order effects that slow economic growth and trigger a recession, causing more panic, driving the VIX higher and crypto lower. The Russia-Ukraine risk may have peaked and could de-escalate. The VIX has room to fall, which could benefit crypto.The conflict is still evolving and near term we think the news flow could drive markets. Anything could happen when tensions are high, but we would not price a global conflict or an economic slowdown as likely right now. 
Bearish Sentiment Sentiment has some room to deteriorate further. While already low, the adjustment hasn’t been as sharp as past periods, and may signal markets need to experience further capitulation.  Sentiment is nearly as negative as it was during the pandemic. Investors are already too bearish, sellers have capitulated, and markets are due for a rally. The situation is nowhere as impactful on the economy as the COVID crisis. Sentiment could deteriorate somewhat if markets get a new negative headline, but positioning is already very fearful, and sentiment has far more room to rise from current levels.
Past Invasions There may be further escalation. Russia’s actions foreshadow a new cold war with a more lasting impact than past invasions. Stocks and crypto may take longer to bottom. Stocks bottomed just before an “invasion” five out of five times. Crypto has been trading like a risk asset similar to stocks and both markets will rally now that Russia has invaded. 

The US and Russia are not going into a cold war. The swift action gives markets more certainty than a gradual escalation that grinds markets lower. History suggests that odds favor a stock rally after an invasion. 

Crypto assets and stocks have had a high correlation that may continue and boost crypto prices. 

Long Term StoryCrypto behaving like a risk asset during the recent correction is a negative for the geopolitical hedge and store of value thesis. The market cap of Bitcoin will eventually reach the market cap of physical gold and the current ratio offers a good long term risk/reward. Crypto is a tech growth play that extends well beyond the gold narrative. Long term investment story for crypto is still intact. Regardless of short-term market narratives, Bitcoin has proven its ability to maintain and grow purchasing power over the long term and crypto has been a strong investment in tech disruption.
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