How Crypto Might React to the Fed’s Rate Announcement
- The Fed’s hawkish policy shift in 2022 has been an ongoing tailwind for crypto prices.
- Crypto has been battered since last Friday’s hot US inflation data boosted the prospect of a 75bps hike this week.
- If the Fed surprises hawkishly on Wednesday, Bitcoin could fall under $20K and Ethereum under $1K.
How the Fed’s Hawkish Shift Has Battered Crypto Prices
A shift in policy guidance towards higher interest rates and a reduction in the size of its balance sheet from the US Federal Reserve (Fed) has been a key factor behind the cryptocurrency market’s fall from grace in 2022. The Fed, like many other central banks around the world, has shifted away from its previous ultra-dovish policy of holding interest rates at zero and buying huge quantities of US government bonds and mortgage-backed securities (MBS) in 2020 and 2021.
With most major economies now engulfed by a wave of inflation that shows little signs of slowing just yet, the Fed has shifted to a comparatively hawkish policy stance where it is signaling that interest rates are likely to be lifted well above the so-called “neutral” interest rate of around 2.5%. It is also going to let its balance sheet shrink by refraining from the reinvestment of principal and interest income that it gets on its assets and is mulling active sales of its holdings.
That shift in policy has forced proxies for US interest rates, such as the yield on US treasury bonds and notes, to sky-rocket over the last few months. For example, US 2-year yields were under 0.5% last November versus near 3.4% as of Tuesday, a near 300 bps rise. US 10-year yields, meanwhile, have risen just shy of 200 bps from under 1.50% to around 3.40% as of Tuesday. This rise in the risk-free rate of return, or the discount rate of opportunity cost as some financial costs refer to it, has forced money out of speculative assets.
Crypto has been one of the biggest casualties. Total cryptocurrency market capitalization briefly surpassed $3.0 trillion last November but has since slumped to around $920 billion, with Bitcoin down over 65% from its 2021 highs and Ethereum down around 75%. Things have been particularly ugly over the past five days, with the two largest cryptocurrencies shedding over 25% and 30% respectively.
One of the main reasons why things got so ugly over the last few days is because, last Friday, US Consumer Price Index data showed a further rise in price pressures in the US economy, a surprise for most market participants who had been buying into the narrative that inflation in the US had now peaked. The Fed, which has signaled its intent to raise rates in 50 bps intervals over the course of the next few meetings, had also been buying into this narrative.
Fed Now Expected to Hike Rates by 75bps
On Monday, the Wall Street Journal and other major US financial news outlets seemed to run coordinated stories speculating that the Fed, in wake of the latest US inflation data, might opt to go with a larger 75 bps rate hike at this Wednesday’s policy meeting. That would lift the target interest rate range to 1.50-1.75% from its current 0.75-1.0%. Various veteran traders and market analysts said this reporting seemed to have been directed by the Fed, who aren’t allowed to communicate with the public via normal channels during the so-called blackout period in the days leading up to each Fed meeting.
The result is that it is now the market’s base case expectation for the Fed to raise interest rates by 75 bps on Wednesday. Given that markets are also now pricing for the Fed to take interest rates to nearly as high as 4.0% in 2023, the central bank’s updated “dot plot” graph will also be in focus. Market participants will want to see how high Fed members themselves expect to take interest rates in 2023 and then how much (if at all) they think they can lower them in 2024 and beyond. New quarterly economic forecasts will also be released, which will give an insight as to the Fed’s expectations for growth, inflation and the labour market.
Bitcoin Price to Fall Sub-$20,000, Ethereum Sub-$1,000 on Hawkish Fed Surprise
The cryptocurrency market reaction will be determined by how hawkish the Fed is relative to the market’s expectations. For example, if the Fed is more hawkish, by raising interest rates by 100 bps or by signaling interest rates above 4.0% in 2023 (via the dot plot) and revising higher its inflation forecast, this would likely send crypto into a tailspin. For Bitcoin, that likely means a collapse to sub-$20,000 levels and for Ethereum a collapse to sub-$1,000 levels.
Alternatively, if the Fed isn’t as dovish as what markets expect, for instance by only raising interest rates by 50 bps, this would see US yields drop aggressively, the US dollar likely weakens and crypto makes a big intra-day comeback as a result. For Bitcoin, that might mean a jump back into the upper $20,000s and for Ethereum, a move back above $1,500.
In reality, a big surprise isn’t too likely as that hasn’t been the Fed’s style under Chairman Jerome Powell. Powell tends to prefer to guide markets regarding what to expect in the run-up to each meeting, then to deliver almost exactly what is expected. But the fact of the matter is that, with inflation conditions in the US worsening, the Fed is going to sound very hawkish. At a time when the US economy is also rapidly slowing (some think it might already be in a recession), risks remain tilted to the downside for crypto prices, even if the Fed doesn’t surprise on the hawkish side relative to market expectations.