How Does the Feds Interest Rate Cuts Impact the Cryptocurrency Market?

How Does the Feds Interest Rate Cuts Impact the Cryptocurrency Market?The Federal Reserve's key interest rate decisions have far-reaching implications for global markets, including cryptocurrencies like Bitcoin. The cryptocurrency market is often viewed as a hedge against traditional assets and responds swiftly to both rate increases and decreases

How Does the Feds Interest Rate Cuts Impact the Cryptocurrency Market?

The Federal Reserve's key interest rate decisions have far-reaching implications for global markets, including cryptocurrencies like Bitcoin. The cryptocurrency market is often viewed as a hedge against traditional assets and responds swiftly to both rate increases and decreases. When the Fed adjusts its monetary policy, it triggers a chain reaction in cryptocurrency demand, volatility, and liquidity, changes that investors need to closely monitor.

How Interest Rates Affect Cryptocurrency

Rate hikes and cuts have distinct impacts on the cryptocurrency market, largely driven by investor sentiment and the broader economic environment.

What Happens During Rate Cuts?

Central bank or Fed rate cuts are typically a signal of economic weakness. When the Fed lowers interest rates, borrowing costs decrease, often encouraging investments in higher-risk assets, including cryptocurrencies. Historical data shows that following the Fed's 0.25% rate cut in 2020, Bitcoin initially experienced a 60% pullback, subsequently experiencing a phenomenal 1600% surge within the year.

Lower rates tend to divert investors from traditional savings instruments towards more speculative assets like cryptocurrencies. The appeal of Bitcoin as a safe haven asset significantly increases, particularly when concerns about inflation coincide with declining interest rates. A research report by S&P Global supports this notion, highlighting a notable correlation between Bitcoins price fluctuations and monetary policy adjustments. Indeed, periods of low interest rates are often accompanied by Bitcoin price increases, while rapid rate hikes lead to price declines, reflecting broader market trends.

Why Rate Hikes Lead to Crypto Declines?

On the flip side, rate hikes produce the opposite effect. As Cointelegraph points out, rate hikes tighten liquidity in financial markets, diminishing the appeal of risky assets like cryptocurrencies. Rate increases boost the attractiveness of low-risk fixed-income instruments, prompting investors to pull funds away from volatile assets such as Bitcoin.

Cryptocurrency response to reduced liquidity mirrors that of other risky assets: when the Fed signaled its intention to raise interest rates in November 2021, cryptocurrencies declined; this trend continued as the Fed aggressively hiked rates in 2022. Additionally, the collapse of cryptocurrencies like LUNA/UST and the downfall of exchanges like FTX further eroded traders confidence in these digital assets. Bitcoin witnessed a drop of approximately 65% during that period.

Other Contributing Factors

Beyond the Feds rate policy, other factors influence Bitcoin's price:

• U.S. Treasury Yields: It's interesting to observe the correlation between Bitcoins price and the yield curve differential between 10-year and 2-year U.S. Treasury notes. The gap between these assets leads to corresponding adjustments in Bitcoins price.

When short-term U.S. bonds yield higher than long-term bonds, it's known as an inverted yield curve. Normally, long-term bonds offer higher yields because investors are more risk-averse with their money in the short term, so they are more likely to invest in higher-risk assets like Bitcoin, 2-year bonds, stocks, etc. However, when the yield curve inverts, meaning short-term bonds yield higher than long-term bonds, this suggests investors are uneasy about the economic outlook and may exit risk assets, including Bitcoin. Conversely, when long-term bond yields are higher than short-term bond yields (as we see now), it sends a positive signal for riskier instruments such as cryptocurrencies.

• Institutional Investor Bitcoin Purchases: The surge in institutional investor interest in Bitcoin, with hedge funds and asset management firms seeing it as a hedge against fiat currency depreciation and a vital diversification tool, is significant. The growing demand for Bitcoin ETFs as institutional investors seek regulated investment opportunities underscores this trend.

This institutional backing is expected to support Bitcoin price stability and future growth, as reported by Reuters, potentially propelling a bull market rebound. The influx of institutional capital is vital to Bitcoins market growth, contributing to the sustenance of high price levels and instilling long-term confidence in the asset's value.

• Macroeconomic Factors: Chinas recent launch of a massive stimulus package, encompassing interest rate and mortgage rate cuts, liquidity releases, and a pledge to invest over $100 billion to support the stock market, could have significant global market implications. This comprehensive initiative could boost risk-on and liquidity-sensitive asset classes like stocks, gold, and Bitcoin.

Analysts believe that if successful, it might also drive up inflation, currently hovering above zero. This move, a departure from China's usually gradualist approach, marks a substantial shift in its economic strategy and its global repercussions will be closely watched.

• Bitcoin as an Inflation Hedge: Bitcoin's fixed supply of 21 million coins makes it a potent inflation hedge. Unlike fiat currencies that governments can print, Bitcoin's scarcity ensures its value remains unaffected by inflationary pressures. This became evident in 2021, when US inflation soared to 7% while Bitcoin gained over 300%, acting as a safeguard against currency depreciation.

Bitcoin shares characteristics with gold, often referred to as "digital gold," as both seem to serve as stores of value during periods of high inflation. Bitcoin's decentralized nature ensures it is not subject to government monetary policies, which often fuel inflation.

• Inverse Correlation between Bitcoin and the US Dollar Index: The inverse correlation between Bitcoin and the US dollar is also crucial. When the dollar weakens, Bitcoin tends to strengthen, making it an attractive alternative. This inverse relationship closely resembles the inverse correlation between gold and the dollar, implying that Bitcoin may continue to act as a hedge against fiat currency fluctuations.

While short-term cryptocurrency market volatility is influenced by the Fed's rate policy, Bitcoin's long-term prospects remain positive owing to its ability to offset inflation costs and retain its value as a safe investment. This characteristic makes it appealing to those seeking to preserve purchasing power during times of economic uncertainty.

Medium-Term Implications for Crypto

Analyzing the above fundamentals and keeping an eye on technical data on charts, we see the following:

In the medium term, looking at the daily chart, Bitcoin has been fluctuating within a descending channel since March 2024. The current price is facing significant resistance at the golden Fibonacci region, where it could signal a bullish scenario for the cryptocurrency market if it breaks through the channels upper boundary, potentially regaining its all-time high (ATH) of $73,500. However, if a correction scenario occurs, the price could drop to the support level of $58,500, aligning with the 38.2% Fibonacci retracement.

Long-Term Implications for Crypto

Throughout 2024, analysts at Standard Chartered have repeatedly released predictions regarding Bitcoins exchange rate movement. In April, they assumed that the BTC price would reach $150,000 by the end of this year. Experts at brokerage Bernstein also believe that the quotation of the main cryptocurrency will surpass its historical peak of $80-90,000 by the end of the fourth quarter. Additionally, Anthony Scaramucci, the founder of hedge fund SkyBridgeCapital, stated that Bitcoin could reach a record $100,000 by the end of the year.

This aligns with the predictions from FBS analysts based on technical analysis of the weekly Bitcoin chart. The $100,000 mark corresponds to the 161.8 Fibonacci level at the break of the cup-and-handle pattern. However, a potential correction scenario might first reach the $50,000 region before surging to a new ATH.

Conclusion

Changes in US interest rates, particularly rate cuts, tend to propel Bitcoin and the broader cryptocurrency market, as lower rates encourage riskier investments. Historical data shows that Bitcoin often rallies after rate cuts, driven by investor appetite for speculative assets and concerns about inflation.

While rate hikes tighten liquidity and lead to price declines, Bitcoins long-term potential remains strong with analysts predicting significant gains by the end of 2024. As an inflation hedge and speculative asset, Bitcoins future hinges largely on broader economic trends and the Feds policies.