Once the dust of deleveraging settles, it will be the fastest horse, accelerating forward.
Author: fejau
Translation: Deep Tide TechFlow
I want to write down a question I have been pondering for a long time: how might Bitcoin perform in the event of a significant shift in capital flows, a situation that Bitcoin has never experienced since its inception.
I believe that once deleveraging ends, Bitcoin will face an incredible trading opportunity. In this article, I will elaborate on my thoughts.
What are the historical key drivers of Bitcoin's price?
I will adopt Michael Howell's research on the historical drivers of Bitcoin's price and use these findings to further understand how these cross factors may evolve in the near future.
As shown in the figure above, the drivers of Bitcoin include:
Overall demand from investors for high-risk, high-β assets
Correlation with gold
Global liquidity
Since 2021, I have used a simple framework to understand risk appetite, gold performance, and global liquidity, focusing on the percentage of fiscal deficit to GDP as a straightforward way to understand the fiscal stimulus that has dominated global markets since 2021.
A higher percentage of fiscal deficit to GDP mechanically leads to higher inflation, higher nominal GDP, and thus higher total corporate revenues, as revenue is a nominal metric. This is a boon for companies that can enjoy economies of scale.
In most cases, monetary policy plays a secondary role in risk asset activity, while fiscal stimulus has been the main driver. As shown in this chart regularly updated by @BickerinBrattle, U.S. monetary stimulus is so weak compared to fiscal stimulus that I will set it aside in this discussion.
As shown in the chart below, among major developed Western economies, the U.S. fiscal deficit as a percentage of GDP is far higher than that of any other country.
Due to the U.S. running such a large deficit, revenue growth has been dominant, leading to the U.S. stock market outperforming other modern economies:
Because of this dynamic, the U.S. stock market has become the main marginal driver of risk asset growth, wealth effect, and global liquidity, thus becoming the magnet for global capital: the United States. This dynamic of capital inflow into the U.S., combined with a massive trade deficit, has led to the U.S. exchanging dollars obtained from abroad for goods, which are then reinvested in dollar-denominated assets (such as government bonds and MAG7), making the U.S. the main driver of global risk appetite.
Now, back to Michael Howell's research mentioned above. Risk appetite and global liquidity have been primarily driven by the U.S. over the past decade, and this trend has accelerated since the COVID-19 pandemic due to the U.S. running such a large fiscal deficit compared to other countries.
Therefore, Bitcoin, although a global liquidity asset (not just U.S.), has increasingly shown a positive correlation with the U.S. stock market since 2021.
Now, I believe the correlation with the U.S. stock market is spurious. When I use the term "spurious correlation" here, I mean from a statistical perspective, where the actual driving factor is a third variable not shown in the correlation analysis. I believe this factor is global liquidity, which, as we mentioned above, has been dominated by the U.S. for nearly a decade.
As we delve into the discussion of statistical significance, we must also establish causality, not just correlation. Fortunately, Michael Howell has also done some excellent work in this area, establishing a causal relationship between global liquidity and Bitcoin through Granger causality tests.
So, what kind of benchmark starting point does this provide us?
Bitcoin is primarily driven by global liquidity, and since the U.S. is the main driver of increased global liquidity, a spurious correlation has emerged.
In the past month, as we speculate on the goals of Trump's trade policy and the restructuring of global capital and commodity flows, some major narratives have emerged. I see them as:
The Trump administration wants to reduce trade deficits with other countries, which mechanically means reducing the flow of dollars to foreign countries, which will not be reinvested in U.S. assets. A reduction in trade deficits cannot happen without this situation occurring.
The Trump administration believes that foreign currencies are artificially suppressed, making the dollar artificially strong, and hopes to rebalance this. In short, a weaker dollar and stronger foreign currencies will lead to rising interest rates in other countries, prompting capital to flow back to capture these better-performing rates under adjusted foreign exchange conditions, as well as domestic stocks.
Trump's "shoot first, ask questions later" approach in trade negotiations has led other countries to escape the thin fiscal deficits compared to the U.S. (as mentioned above) and invest in defense, infrastructure, and general protectionist government investments to become more self-sufficient. Regardless of whether tariff negotiations are downgraded (e.g., with China), I believe this matter is set in stone, and countries will continue to pursue this goal.
Trump wants other countries to increase their defense spending as a percentage of GDP and contribute more to NATO spending, as the U.S. has borne a large share of these costs. This will also increase fiscal deficits.
I will set aside my personal views on these points for now and focus on the potential impacts if we advance according to the logical endpoints of these narratives:
Capital will leave dollar-denominated assets and flow back to their home countries. This means the U.S. stock market will underperform relative to other regions, bond yields will rise, and the dollar will weaken.
This capital will flow back to places where fiscal deficits are no longer constrained, and other modern economies will begin to spend and print money lavishly to fund these increased deficits.
As the U.S. shifts from a global capital partner to a more protectionist role, holders of dollar assets will have to increase the risk premium on these once-perfect assets and mark them with a broader margin of safety. As this process unfolds, it will lead to rising bond yields, and foreign central banks will seek to diversify their balance sheets, moving away from merely holding U.S. Treasuries to other neutral commodities like gold. Similarly, foreign sovereign wealth funds and pensions may also pursue this diversification.
The opposite of these views is that the U.S. is the center of innovation and technology-driven growth, and no other country will overturn this idea. Europe is too bureaucratic and socialized to pursue capitalism like the U.S. I sympathize with this view, which may mean this is not a multi-year trend but a mid-term trend, as the valuations of these tech companies will limit their upside for a while.
Returning to the title of this article, the first trade is to sell off the dollar assets that the world holds too much of, avoiding the ongoing deleveraging. Because the world holds too many of these assets, when risk limits are triggered by large fund managers and more speculative players like multi-strategy hedge funds with strict stop-losses, this deleveraging could become chaotic. When this happens, we will see days similar to margin calls, where all assets need to be sold to raise cash. Now, the strategy of trading is to survive and maintain ample liquidity.
However, as the deleveraging calms down, the next trading begins—shifting to a more diversified portfolio: foreign stocks, foreign bonds, gold, commodities, and even Bitcoin.
On market rotation days and non-margin call days, we have already begun to see the formation of this dynamic. The dollar index (DXY) is falling, the U.S. stock market is underperforming compared to other regional markets, gold is soaring, and Bitcoin is surprisingly resilient compared to traditional U.S. tech stocks.
I believe that as this situation unfolds, the marginal increase in global liquidity will shift to a completely opposite dynamic that we are accustomed to. Other regions will take on the responsibility of increasing global liquidity and risk appetite.
As I contemplate this diversification of risk in the context of the global trade war, I worry about delving too deeply into the tail risks of other countries' risk assets, as there are some significant landmines regarding potential bad tariff news. Therefore, this makes gold and Bitcoin attractive options for global diversified investment during this transition.
Gold has been rising absolutely and is now setting new historical highs every day, reflecting this institutional shift. However, while Bitcoin has shown surprising resilience throughout this institutional transition, its beta correlation with risk appetite has so far limited its performance, failing to keep pace with gold.
Therefore, as we move towards a rebalancing of global capital, I believe the next trade after this will be Bitcoin.
When I compare this framework with Howell's correlation research, I can see how they come together:
The U.S. stock market cannot be influenced by global liquidity but can only be affected by liquidity measured by fiscal stimulus plus some capital inflows (but we have just established that this aspect of flow may stop or even reverse). However, Bitcoin is a global asset that reflects a broad perspective of this global liquidity.
As this narrative establishes itself and risk allocators continue to rebalance, I believe risk appetite will be driven by other regions rather than the U.S.
Gold has performed very well, so for the Bitcoin portion correlated with gold, we can check that box as well.
Given all of this, I see for the first time in financial markets the potential for Bitcoin to decouple from U.S. tech stocks. I know this idea often marks local peaks for Bitcoin. The difference this time is that we see the potential for a significant change in capital flows, which will make it lasting.
Thus, for a macro trader like me with a risk appetite, Bitcoin feels like the purest trade here. You cannot impose tariffs on Bitcoin; it does not care which border it is located at, it provides a high beta for the portfolio without the current tail risks associated with U.S. tech, and I do not have to comment on whether the EU can get its act together, providing a pure exposure to global liquidity, not just U.S. liquidity.
This market regime is precisely why Bitcoin was born. Once the dust of deleveraging settles, it will be the fastest horse, accelerating forward.
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