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By Kyle Anthony, Benzinga
The global macroeconomic landscape is changing, as the Bank of Canada (BoC) and European Central Bank (ECB) recently cut interest rates in their respective economies due to declining inflation and encouraging economic readings in recent months. The reduction of interest rates by both the BoC and ECB raises expectations of interest rate cuts by the Federal Reserve (Fed) in the near future. For many cryptocurrency investors, such an action would positively impact their cryptocurrency investments and open up the opportunity to achieve additional liquidity.
The Macroeconomic Backdrop
The Federal Reserve adjusts the federal funds target rate range in response to what’s happening in the economy. Adjusting rates helps the Fed achieve conditions that satisfy their dual mandate: keeping prices stable and maximizing employment. While the considerations and variables that underpin the monetary policy actions of the Fed are numerous, in simplified terms, the Fed raises interest rates when the economy starts overheating (i.e. elevated inflation) and cuts rates when the economy looks weak (i.e. high unemployment). Against the backdrop of elevated inflation stemming from the COVID-19 pandemic, the Federal Reserve raised rates 11 times between March 17, 2022 and July 27, 2023. In subsequent meetings about the federal funds target rate, the Fed maintained the current rate level of 5.25% to 5.50%.
With U.S. inflation significantly down from historical highs and the actions of other central banks being a motivating factor, the desire for quantitative easing – the reduction of interest rates and increase in the money supply through the purchase of securities by the central bank – is growing among investors and individuals alike.
Interest Rate Change Impact on Cryptocurrency
Cryptocurrencies, like any risk asset such as equities or fixed income, are impacted by interest rates. A lower interest rate stimulates the economy, encouraging consumer spending and investment, increasing borrowing and buoying economic activity. Thus, it can be a boon for asset acquisition, driving prices up. It is also worth noting that lower rates disincentivize individuals from saving their money via certificates of deposits and other term-to-maturity instruments, instead compelling many to seek out riskier assets like crypto to pursue higher returns. This increased demand can drive up crypto prices.
The relationship between interest rates and cryptocurrencies can be gleaned from the historical price of Bitcoin. During the era of extremely low interest rates, Bitcoin’s price reached then record highs, surpassing the $60,000 price threshold. However, a material drawdown, approximately 70%, occurred once the Fed began raising rates to combat rising inflation. Though Bitcoin’s price has recovered, this was due to events such as its halving and the SEC’s approval of spot Bitcoin ETFs. Once a macroeconomic change – such as the reduction of interest rates – occurs, the price of Bitcoin and other cryptocurrency assets may be pushed upward. The chart below highlights the inverse relationship between the federal funds effective rate and the price of Bitcoin.
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Featured photo by André François McKenzie on Unsplash.
Benzinga is a leading financial media and data provider, known for delivering accurate, timely, and actionable financial information to empower investors and traders.
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