The Predictive Power of High Yield Bonds on Bitcoin's Price
Executive Summary
A strong correlation exists between Bitcoin's relative value versus HYG and its future performance in USD over three-month cycles. The study found that when Bitcoin is undervalued relative to HYG, it tends to outperform in the following months, and vice versa.
The HYG/BTC differential serves as a potential predictive indicator for Bitcoin's price movements. When the difference between HYG and Bitcoin prices widens, it signals a potential decrease in Bitcoin's price over the next three months. Conversely, when the difference narrows, it suggests a potential increase in Bitcoin's price, providing a valuable indicator.
The relationship is most significant over periods of one month or longer, suggesting its utility for medium-term price forecasting.
Background
High yield corporate bonds, colloquially known as "junk bonds," occupy a distinctive niche in the fixedincome market. These debt securities, issued by companies with credit ratings below investment grade, offer elevated interest rates to compensate investors for the increased risk of default. The dichotomy between their higher yields and inherent volatility makes them a subject of considerable interest and debate among financial professionals and academics alike.
The appeal of high yield bonds lies primarily in their potential to generate superior income streams, particularly in low-interest-rate environments. This characteristic has led to their increasing prominence in diversified portfolios, where they serve as a tool for yield enhancement. However, the risk-return profile of these instruments is notably different from their investment-grade counterparts. High yield bonds exhibit heightened sensitivity to macroeconomic conditions, with their prices often experiencing
significant fluctuations during periods of economic uncertainty or market stress.
The iShares iBoxx High Yield Corporate Bond ETF
The iShares iBoxx High Yield Corporate Bond ETF (HYG) is an exchange-traded fund (ETF) that seeks to track the investment results of the Markit iBoxx USD Liquid High Yield Index, which is composed of U.S. dollar-denominated, high yield corporate bonds. HYG provides broad exposure to the high yield bond market, making it a popular choice for incomefocused investors looking to gain access to this segment of the fixed-income market. This investment comes with higher volatility and potential for capital loss, especially in times of economic downturns when credit risk becomes more pronounced.
High Yield and Bitcoin
High yield investments, like junk bonds, and Bitcoin are connected through the concept of investor risk appetite. Both assets appeal to investors who are willing to take on more risk in exchange for the potential of higher returns. In periods when interest rates are low, and there is an abundance of capital, investors often look for opportunities that offer greater returns than traditional investments, driving demand for both high yield bonds and Bitcoin.
The relationship between high yield and Bitcoin can also be understood in terms of how they respond to economic cycles. When the economy is expanding and credit is easy to obtain, both high yield bonds and Bitcoin tend to perform well as investors are more willing to take on risk. Conversely, during economic downturns, or when interest rates rise, investors may shift away from riskier assets, leading to declines in both high yield bonds and Bitcoin.
In essence, both high yield bonds and Bitcoin are sensitive to the availability of capital and changes in investor sentiment. They thrive in environments where risk-taking is rewarded and can suffer when market conditions turn unfavorable. This connection makes
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The Macroeconomic Factor Model
Prior research (“Bitcoin Cycles: The Macroeconomic Factor Model”) explored the cyclical nature of Bitcoin's price movements, focusing on macroeconomic factors as key drivers. This research note explains how the availability of risk capital and the purchasing power of that capital influence Bitcoin's boom and bust cycles. The study challenges popular explanations like Bitcoin halvings, speculative mania, and market manipulation, arguing instead that macroeconomic conditions offer a more consistent explanation for Bitcoin's price behavior.
The methodology involves analyzing Bitcoin's price relative to its adoption curve and comparing this with a High Yield Total Return Index and the U.S. Dollar Index. The research employs a two-factor regression model, which integrates these indices to assess their impact on Bitcoin’s price. The study also modifies the model to account for Bitcoin's inelastic supply and elastic demand, further refining the analysis.
The conclusion in that paper suggest that Bitcoin's price cycles are largely driven by macroeconomic factors, particularly the availability of risk capital and the strength of the U.S. dollar. The research finds that low interest rates, which increase the availability of risk capital, tend to precede Bitcoin price booms. Conversely, a strong U.S. dollar often signals the end of these booms. The study concludes that future Bitcoin cycles will likely be influenced by these same macroeconomic conditions rather than by intrinsic factors like halvings or market manipulation, making them essential considerations for investors.
This research builds upon the foundation laid by prior studies examining Bitcoin's price behavior through a macroeconomic lens. While previous work cast a wide net over various economic factors, the current approach hones in on a specific relationship: that
between high yield corporate bonds and Bitcoin, but does so over a shorter time period.
Methodology
We compared the price of iShares iBoxx $ High Yield Corporate Bond ETF (HYG) to the price of Bitcoin for the period Jan 2022 - August 2024 (Figure 1). This relationship is used to build a HYG index scaled to Bitcoin price (Figure 2). The differential between these two prices, HYG/BTC is plotted as the black line in Figure 3, with the lognormal scale on the righthand side.
Figure 1
HYG vs. BTC
Figure 2
Figure 3
HYG/BTC and BTC 3-month Forward Return
A high value indicates Bitcoin price is undervalued relative to HYG, and a low value indicates the inverse. note the seasonal recurrence of depressed bitcoin valuation every September, a phenomenon known as seasonality. Seasonality is discussed in detail in a separate note "Proof of Altseason."
Next, we calculated the three-month forward return for Bitcoin price. This is shown in orange with the scale on the left-hand side. This chart is read by looking at a certain date, and then reading the corresponding percentage on the left-hand side. The value is the rate of return that Bitcoin earned after the date. For example, in September 2023 the value was about 70%. This means that Bitcoin surged 70% over the next three months, finishing much higher in December 2023 (Bitcoin went from about $25k to $42k in that time.)
Discussion
There seems to be a strong correlation between Bitcoin's relative value vs. HYG, and its future performance in USD, in the short term. This relationship manifests in three-month cycles.
Our analysis showed that there is indeed a long-term relationship between the HYG/BTC ratio and the 3month forward return on Bitcoin. Specifically, when the difference between HYG and Bitcoin widens, it has a predictive power over how Bitcoin will perform in the next three months. When the difference between the HYG ETF and Bitcoin prices increases, it signals Bitcoin's is likely to fall in the next three months. On the other hand, if the difference shrinks, Bitcoin's price tends to go up. This relationship is plotted in Figure 4.
We found that this relationship starts to significantly influence Bitcoin's forward returns over periods of approximately one month or more. This means that if the indicator HYG/BTC shows a notable change, one might consider it a signal that Bitcoin's price could adjust in response, but this adjustment might take
some time to fully materialize—about one month or longer.
Figure 4
HYG/BTC vs. BTC Forward Return
This finding is significant. It suggests that by monitoring the difference between HYG and Bitcoin, one can gain insights into future Bitcoin returns with a horizon of three months.
As of this writing, the indicator signals HYG/BTC of 25%. This corresponds to a lognormal increase of 60% in the next three months. Assuming a price of 60,000, the relationship suggests the price in November would be around $109,000.
Caveats and Considerations
While these findings are intriguing, they come with important caveats to consider:
Data Period and Frequency
The analysis is based on daily data from January 1, 2022, to August 24, 2024. This is a short period that includes significant global events, economic shifts, and market conditions that may not be representative of future periods. The results could be influenced by these specific conditions, and the relationship might not hold in different economic environments.
Model and Testing Assumptions
The VECM approach we used to validate the relationship assumes that the long-term relationship between HYG and Bitcoin will continue in the future as it did in the past. However, both the bond market and the cryptocurrency market are subject to abrupt changes in sentiment, regulation, and external shocks, which could disrupt this relationship.
Also, while the model identifies a cointegrated relationship, it does not guarantee causality. The observed relationship could be coincidental or driven by other factors not included in the analysis.
Market Dynamics
The cryptocurrency market, in particular, is highly sensitive to news, technological developments, and regulatory changes that are not captured by traditional financial models. While the HYG/BTC indicator provides a historical relationship, it cannot predict sudden, market-moving events unique to Bitcoin.
For example, the relationship broke down completely in the second half of 2022. Bitcoin did not follow HYG due to several crypto-specific events that overshadowed broader market trends. Key factors included the collapse of major crypto platforms like FTX, leading to a crisis of confidence in the crypto market, and increased regulatory scrutiny that spooked investors. These events created significant selling pressure and liquidity issues in the cryptocurrency market and Bitcoin's price was more heavily influenced by these internal shocks and fears of systemic risk within the digital asset sector.
Conclusions
This research highlights three main conclusions regarding the relationship between high yield corporate bonds, represented by HYG, and Bitcoin's future performance. First, we found a significant predictive relationship between the indicator (HYG/BTC) and Bitcoin’s three-month forward returns. Specifically, when the indicator is high, Bitcoin's price is more likely to decrease in the subsequent months,
and when the indicator is low, Bitcoin’s price is likely to increase. This relationship is most evident over periods of one month or longer, suggesting that the indicator can serve as a useful tool for medium-term Bitcoin price forecasting.
Second, the study underscores the impact of macroeconomic conditions on Bitcoin's price cycles. The availability of risk capital, often reflected in high yield bond performance, plays a critical role in Bitcoin's boom and bust cycles. As interest rates and credit conditions fluctuate, they influence investor sentiment and risk appetite, which in turn affects both high yield bonds and Bitcoin. This connection provides a bridge between traditional financial markets and the cryptocurrency space, offering investors a broader perspective on the factors driving Bitcoin’s price.
References
Cane Island Digital Research. (2020). “Proof of Altseason. www.cane-island.digital
—.. (2023). “Bitcoin Cycles: The Macroeconomic Factor Model.” www.cane-island.digital
iShares iBoxx $ High Yield Corporate Bond ETF (HYG) Stock Price, News, Quote & History https://finance.yahoo.com/quote/HYG/
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The Predictive Power of High Yield Bonds on Bitcoin's Price
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