The impact of Federal Reserve’s rate cut on crypto
On the calm Wednesday afternoon of 18th September 2024, the United States Federal Reserve issued an FOMC statement that they had decided to lower the target range for the federal funds rate by 0.50 percentage points from the initial 5.5%. The Fed’s Chairman, Jerome Powell, expressed his satisfaction with what they had done, calling it a good start. He described the move as a “recalibration” to match the inflation rates that have been going down, steadily approaching their 2% target.
If you are wondering how the rate cut affects you, you are in the right place. The aim of the cut, according to Jerome, is to reduce the current 4.2% unemployment rate and control inflation. Since the Fed’s interest rate serves as a benchmark to other interest rates in the economy, your borrowing costs, including your credit cards, personal loans, car loans and mortgages, will ease. The cut may also be good news for Bitcoin and other cryptocurrency markets because it can mean higher demand and investments in digital assets.
Relationship between interest rates and crypto
Though cryptocurrencies are not controlled by central or government agencies, they are not immune to the effect of interest changes by the central banks. In fact, a study by S&P Global in May 2023 showed that on a daily rolling three-month basis, interest rates and the crypto index have exhibited an inverse relationship 63% of the time since May 2017. It is worth noting that interest rates are not the only factor that affects crypto prices but that their complex relationship has a part to play.
When interest rates increase, the cost of borrowing also increases, thus controlling inflation because the amount of money flowing into the economy decreases. Traditional assets like saving accounts and government bonds then become more attractive because of the possibility of high returns on medium-risk investments. As a result, investors may shift their focus away from riskier options like crypto, potentially leading to price drops. A case in point would be December 2017- December 2018, when the US Fed had five 0.25 percentage points interest hikes in its quest to curb inflation. The price of Bitcoin went from an ATH of about $20,000 in December 2017 to around $3200 in one year – an over 80% loss.
On the other hand, when the interest rates reduce, borrowing becomes cheaper, and more money circulates in the economy. Banks also offer lower saving rates, possibly increasing risk appetite for investors pursuing higher returns. In 2020, when interest rates dropped twice by 50 basis points and once by 100 basis points, Bitcoin prices increased by a whopping 416% from the beginning of the year.
What is expected now?
Bitcoin seems to be following the inversely proportional trend, seeing that after the Fed cut US interest rates by 50 basis points on Wednesday, it surged by more than 6% to an intraday high of $63,800 on Thursday. Ether rose by 6%, and the Solana token jumped 10%.
Richard Teng, chief executive of global crypto exchange Binance, expressed that despite the uncertain effects of the Fed rate cuts, their significant impact on the global economy and, in turn, digital asset prices could potentially increase market activity. The expected increase is due to reduced borrowing costs and enhanced liquidity, which create a favorable environment for digital assets. Matthew Sigel, head of digital assets research at VanEck, also pointed out a higher likelihood of strong Q4 performance from bitcoin as a result of the Fed cut.
Additionally, other financial assets, such as stocks, increased after the interest rate was lowered. The S&P 500 rose Monday as traders looked to build on the sharp gains seen last week following the Federal Reserve’s interest rate cut. The broad market index added 0.23%, while the Nasdaq Composite traded higher by 0.19%. The Dow Jones Industrial Average gained 30 points, or 0.07%. The S&P 500 energy sector advanced more than 1%.
Final thoughts
Some people argue that the Federal Reserve’s interest rates don’t have a big impact on cryptocurrency holders. This is especially so with long-term crypto investors, who feel like they may be less affected by short-term Fed policy changes. They believe in cryptocurrencies’ long-term potential and are prepared to withstand volatility. Regardless of the side of the coin you lie on, though complex, the correlation between interest rates and crypto exists.
You should keep in mind that the cryptocurrency market is highly volatile, and other factors, such as government regulations, news, technology and more, affect crypto prices. As a matter of fact, the value of a cryptocurrency can rise or fall by 10-20% or more in a single day. Investors should not rely only on changing interest rates; they should stay up-to-date with the latest trends and patterns in the market and consider their risk tolerance to help them make informed decisions.
