The global macroeconomic landscape is evolving as the Bank of Canada (BoC) and European Central Bank (ECB) recently cut interest rates due to declining inflation and positive economic indicators. These moves have heightened expectations that the Federal Reserve (Fed) may also reduce interest rates soon. Such a shift could significantly impact the cryptocurrency market, presenting both opportunities and risks for investors.
The Federal Reserve adjusts the federal funds target rate range in response to economic conditions to achieve its dual mandate of stable prices and maximum employment. Historically, the Fed raises rates to cool an overheating economy and cuts rates to stimulate a weak one. Since the COVID-19 pandemic, the Fed raised rates 11 times between March 17, 2022, and July 27, 2023, to combat elevated inflation. Currently, the rate is maintained between 5.25% and 5.50%.
With U.S. inflation significantly down from historical highs and the actions of other central banks as a motivating factor, the desire for quantitative easing is growing among investors. Quantitative easing involves reducing interest rates and increasing the money supply through the purchase of securities by the central bank.
Interest rates profoundly impact cryptocurrencies, similar to other risk assets like equities or fixed income. Lower interest rates stimulate the economy by encouraging consumer spending and investment, increasing borrowing, and buoying economic activity. This environment can drive asset prices up, including cryptocurrencies. Lower rates also disincentivize saving in traditional instruments, pushing investors towards riskier assets like crypto for higher returns, thereby driving up demand and prices.
The historical price of Bitcoin illustrates this relationship. During periods of extremely low interest rates, Bitcoin's price reached record highs, surpassing $60,000. However, a significant drawdown of approximately 70% occurred once the Fed began raising rates to combat inflation. Although Bitcoin's price has since recovered due to events like its halving and the SEC’s approval of spot Bitcoin ETFs, any macroeconomic change such as a reduction in interest rates could push Bitcoin and other cryptocurrency prices upward.
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Featured photo by André François McKenzie on Unsplash.
