How does the Fed rate affect the price of bitcoin? All you need to know

Introduction

The Federal Reserve rate is one of the most important economic indicators that can have a huge impact on the price of Bitcoin. This article will explain how the Fed rate affects the price of Bitcoin and why it is important for investors to understand this relationship. We will look at how the Fed rate affects the demand and supply of Bitcoin as well as how it can cause volatility in the market. Finally, we will discuss why it is important to keep an eye on the Fed rate and how it can affect the future price of Bitcoin.




How does the Fed rate affect the price of bitcoin?


AdvancedTrading and investmentEconomic theory

How does the Fed rate affect the price of bitcoin?


AdvancedTrading and investmentEconomic theory

Main

  • The base rate of the Federal Reserve System (FRS) is the lending rate at which banks provide short-term loans to each other. If a bank needs to transfer or “cash out” funds to a client, but its reserves are not enough, then it borrows capital from another financial institution for a short period of time at a minimum percentage.
  • The Fed’s base rate is the main instrument of monetary policy in the United States. A change in the base rate has a significant impact on the state of the financial system, the stock market and is reflected in the value of various asset classes, including bitcoin and cryptocurrencies.
  • Historical data shows an inverse relationship between the Fed’s base rate and the price of bitcoin: a decrease in the Fed’s rate leads to an increase in the capitalization of bitcoin and other digital assets, and vice versa.

How are the Fed’s base rate and risk level related?

Every financial asset has a certain level of risk. From the point of view of macroeconomics, assets are divided into two main types:

  1. Risky assets are instruments with a floating yield, which depends on the behavior of investors, dynamics and market conditions. Risky assets include shares of public companies. Bitcoin does not yet have a clear status, however, under certain market conditions, it behaves as a volatile and high-risk asset, the price movements of which coincide with the dynamics of the stock market.
  2. Low-risk or defensive assets have low returns but are generally price stable. They act as a store of value during periods of economic downturns. These assets include certain fiat currencies, precious metals (particularly gold), and highly rated government and corporate bonds. In addition, an increase in the rate leads to an increase in the yield of US government bonds, which are the main anti-crisis asset in the world.

Why does the price of bitcoin change when the Fed raises the rate?

During a period of economic growth, the Fed keeps the base rate low – this stimulates investment and reduces the overall savings rate. Since high-risk assets have a higher potential for return, they are more popular among investors.

During an economic recession or crisis, the Fed raises the base rate. This encourages economic agents to increase their savings, sell high-risk assets and go to a “safe haven”, that is, invest in conservative instruments, the profitability of which is growing.

How does a change in the Fed rate affect the price of bitcoin?
Fed rate and bitcoin price. Data: Trading View

When the Fed raises the base rate, banks increase the interest on loans to individuals and legal entities, and investments become more expensive. This slows down the economy in all areas, falling demand for goods, services and other components of any economy.

Too much tightening or untimely termination of the process of raising the rate can lead to a recession not only in the United States, but also in other countries due to the dominance of the dollar in the global economy.

In such tough conditions, investors tend to choose assets with predictable returns like government bonds, rather than risky, unpredictable assets, which include bitcoin.

The Fed rate is an important, but not a determining factor in the price of a cryptocurrency. Do not make decisions based only on this parameter.

Who considers bitcoin a risky asset and why?

While some investors perceive bitcoin as “digital gold”, that is, as a store of value, others pay more attention to its high volatility.

At the beginning of 2022, Grayscale specialists classified bitcoin as a high-risk asset, highlighting a long-term uptrend outpacing gold and high cryptocurrency volatility as a good opportunity for speculation.

In April, analysts from Arcane Research announced that the correlation between the price of bitcoin and the Nasdaq Composite index, which reflects the value of the US technology sector, has reached a peak. Technology stocks are considered a volatile “growth asset”.

In early June 2022, Bloomberg Intelligence commodities strategist Mike McGlone also drew parallels between the fall of the crypto market and the “great pullback” in high-risk asset prices during the 2008 and 1987 crises. Although McGlone expects the first cryptocurrency to become a store of value, he now considers bitcoin to be a risky asset.

According to Kaiko, by June 2022, bitcoin reached its maximum correlation with the leading stock indices S&P 500 and Nasdaq 100, which also indicates its volatile, high-risk nature.

The first cryptocurrency does not always correlate with risky assets. In 2020, experts from the fund management company VanEck Global recorded a record correlation between bitcoin and gold. In 2021, the head of ARK Investment Management, Cathy Wood, said that big business is considering bitcoin as a tool to hedge against dollar inflation. A striking example of this approach is MicroStrategy, which holds part of the capital in the first cryptocurrency.

What happens to the price of bitcoin when the Fed eases policy?

When the rate is lowered, the Fed begins to acquire assets on the open market, injecting liquidity into the system. There is more money, loans are cheaper, the investment climate is improving. All this accelerates economic growth, allowing businesses and citizens to access cheaper money through low interest rates.

Loose policies and more cheap money encourage investors to lower risk requirements and invest in new technologies, developments, construction, startups, funds and other risky vehicles, including cryptocurrencies.

Another tool that the Fed can use is the so-called quantitative easing. It was first used during the 2008 crisis. Then the Fed, by increasing its own monetary balance through the printing press, began to buy unreliable securities and bonds of large companies in the US market that were experiencing financial difficulties.

Thus, the regulator supported the economy and avoided massive defaults. Although quantitative easing led to a sharp increase in the money supply and increased risks of inflation.

Shortly thereafter, the Bitcoin network began to operate, which was a response to problems in the financial system and the actions of the authorities.

The Fed applied quantitative easing again, but on a much larger scale, in the spring of 2020, when a lockdown was announced in the United States due to the coronavirus pandemic.

From March to June 2020, the Fed pumped nearly $3 trillion into the economy. This allowed not only to stop the fall of the stock market, but also provoked a rapid rise in prices for high-risk assets. At the same time, the cryptocurrency market began to grow.

However, this cycle of growth ended with a sharp increase in dollar inflation caused by the actions of the Fed, which negatively affected the price of bitcoin.

Will bitcoin remain a risky asset?

There is no exact answer to this question, but in the past, researchers have repeatedly recorded the correlation between the prices of bitcoin and gold, a traditional defensive asset.

By opinion According to Dan Morehead, founder of the US crypto fund Pantera Capital, the Fed has been excessively manipulating the market by buying up an increasing amount of distressed assets, which has already led to problems in the labor markets, government bonds and mortgage lending in the United States. Problems in the US economy will inevitably affect other countries.

At the same time, the only problem with bitcoin, according to Morehead, is an increase in correlation with high-risk assets, in particular with the S&P 500 index during its downturns. The financier is sure that this situation is not something permanent.

Morehead is convinced that sooner or later the paths of cryptocurrencies and traditional assets will finally diverge.

Short answers to frequently asked questions

How does the Fed rate hike affect cryptocurrencies?

The Fed’s rate hike is aimed at “cooling” the US economy. This negatively affects the stock market. Although cryptocurrencies are a separate asset class, they are closely correlated with the stock market, so their prices may also decrease due to a Fed rate hike. Although in the future the correlation may change towards defensive assets, as it has happened more than once.

How will the Fed meeting affect bitcoin?

Until the United States economy begins to show signs of a sustainable recovery, the Federal Reserve (Fed) is likely to raise rates. At a meeting in July 2022, the regulator has already raised it by 0.75%. By analysts’ opinionthe Fed rate will be raised by at least several of the next Fed meetings.

Why is the cryptocurrency rate falling?

One of the main factors why the cryptocurrency exchange rate is falling in 2022 is the general crisis in the global economy. That, in turn, arose due to the coronavirus pandemic. Price increases for entire categories of goods have risen due to disruptions in supply chains, and massive liquidity programs in advanced economies have led to record inflation.

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Conclusion

In conclusion, the Federal Reserve rate does have an impact on the price of Bitcoin, but it is not the only factor that influences it. The demand for Bitcoin, news about cryptocurrency, and the overall market environment all play a role in its price. Ultimately, the Federal Reserve rate can affect the price of Bitcoin, but it can also be affected by many other things.

FAQ

How does the Fed rate affect the price of bitcoin?

The Fed rate, or the Federal Funds Rate, is the rate of interest at which banks lend money to each other overnight to cover short-term liquidity needs. It’s closely watched by investors and can have an impact on the price of bitcoin. When the Fed rate is low, investors tend to be more willing to take on risk, which can lead to increased demand for bitcoin and consequently, an increase in its price. On the other hand, when the Fed rate is higher, investors tend to be more cautious, leading to decreased demand for bitcoin and a decrease in its price.

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