Updated: Jan 27
All financial markets, including the crypto market, are affected by Federal Reserve policy. That’s why the January 26 FOMC meeting statement along with the Fed chair’s news conference matter so much.
Everyone knows that macro factors have been driving the crypto market as of late –specifically, the Federal Reserve’s reactions to those macro factors. With the crypto market having about a 0.6 correlation to the S&P 500 and Nasdaq in recent weeks, (according to data provider Kaiko), markets seem to be becoming more intertwined.
The major issue of the day is inflation. The original cryptocurrency, Bitcoin, is perceived by many as being an inflation hedge due to its fixed supply. However, Bitcoin reacted to the last few CPI inflation prints by initially rallying and then fading strongly downwards. The accepted rationale is that if inflation gets too hot, the Federal Reserve will hike interest rates. As of this post, the market is expecting three or possibly four rate hikes this year, with the first one expected in March. The market is also expecting the Fed to wind down its QE program in March.
No more "money printer goes brrrrr."
Raising rates and ending quantitative easing (with the expectation of quantitative tightening soon after) signify the beginning of “tight money” policies. The common narrative that cryptos have the strong tailwind of money printing is likely to go away soon. Moreover, many institutions with macroeconomic sensitivity are now participating in the crypto market. If financing gets more difficult and the economy is poised for higher inflation, these investors will likely flee more and more (for a time) towards the perceived safety of risk-off assets. The recent crypto market plunge case in point.
The market has spoken. As of now, crypto more often than not trades like a risk-on asset, not a risk-off asset such as gold. Therefore, it behooves the crypto investor to pay close attention to Fed policy direction.
In Chairman Powell's press conference, he came out more hawkish than expected and the crypto market took a hit. He went as far as to say that he "doesn't rule out raising rates at every FOMC meeting." There are eight FOMC meetings a year (including this one) meaning he's leaving a good deal of room for rate increases.
There are many factors at play affecting the crypto market. It is an election year in the US and President Biden along with the Democratic party want inflation to go down. But they also don’t want the stock market to crash or the economy to slow down from higher rates.
Chairman Powell surely has a tough job ahead of him. Many analysts believe he’s under a great deal of political pressure. Other analysts think the wealthy Republican lawyer and former investment banker is likely quite resistant to politics. He has already been confirmed by the Senate and investors should recall that Powell previously hiked rates when then President Trump wanted low rates.
As of this writing, CME futures are giving a 87.6% probability of a 0.25% rate hike at the March 16th meeting. The remaining 12.4% probability is for a 0.5% rate hike. This is something that investors should be aware of as more inflation and employment data come in.
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