The Federal Reserve’s strategy of raising interest rates may continue, making it difficult for the cryptocurrency industry to recover. For crypto assets to become the hedge against inflation, the industry needs to explore ways to de-link cryptocurrencies from traditional markets. Decentralized finance (DeFi) may perhaps offer a way out by breaking out of legacy financial models.
How Federal Reserve Policies Are Affecting Crypto
In the 1980s, Paul Volcker, Chairman of the Federal Reserve Board, introduced the policy of increasing interest rates to control inflation. Volcker raised interest rates to over 20%, which pushed the economy into a recession by reducing people’s purchasing power. The strategy worked and the Consumer Price Index (CPI) dropped from 14.85% to 2.5%. Even now, the Federal Reserve continues to use the same methodology to reduce high inflation rates.
In 2022, core US inflation hit a 40-year high, forcing the Federal Reserve to steadily raise interest rates throughout the year. This has negatively affected the cryptocurrency market. Mike McGlone, a senior commodity strategist at Bloomberg Intelligence, explained that the Fed’s “gavel” has “been putting pressure on cryptocurrencies this year.” McGlone believes that the Fed’s policies could lead to a crash worse than the 2008 financial crisis.
Market data shows a clear pattern in which Federal Reserve rate hikes correspond to significant drops in cryptocurrency prices. For example, Bitcoin (BTC) prices moved lower on May 6 after the Fed meeting on May 3-4 to raise interest by 0.5%. Similarly, Bitcoin fell to $17,500 after the Fed meeting on June 14-15, where they raised interest rates by 0.75%.
The June rate hike was a major factor in sending cryptocurrencies like BTC and Ether (ETH) down 70% from their all-time highs. As the price charts demonstrate, the Federal Reserve’s policies have a direct correlation to the volatility of the crypto market. This uncertainty prevents the crypto industry from making a definitive comeback. Since cryptocurrencies are a risky asset class, investors are reducing their exposure to cryptocurrencies due to rising interest rates and recession fears.
The Federal Reserve implemented another 0.75% interest rate hike in November. The Fed said it was trying to reduce “inflation to a rate of 2 percent over the long term.” The Fed Committee will continue to raise the fed funds rate to 3-4%. “He anticipates that continued increases in the target range will be appropriate to achieve a monetary policy stance that is tight enough to bring inflation to 2% over time.”
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Given that inflation remains high, there is no reason to believe that the Federal Reserve will stop raising interest rates any time soon. Unfortunately, this is not good news for risky assets like cryptocurrencies.
The future trajectory of Fed policies
In all likelihood, the Federal Reserve will continue its interest rate hikes based on market data feedback. Bank of America wrote: “The Fed will emphasize reliance on data […] will get two more NFP and CPI impressions before the [December] appointment; if they stay hot, another 75 bps is at play, if not, a slowdown to 50 bps is possible.” The strategists added: “The Federal Reserve is not done walking until the data says so.”
Echoing the sentiment, Barclays’ credit research team said: “The Fed needs to see inflation turn around … before turning significantly dovish.” Therefore, there is a high probability that even if the Federal Reserve lowers the rate hike, it will still raise interest rates. Depending on the inflation figures, the Fed could slow down its liquidity tightening measures starting in December, but it will not stop immediately with its inflation mitigation strategies. Therefore, investors should prepare for a long period of crypto market volatility.
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The Federal Reserve intends to create a reverse wealth effect for investors to reevaluate their cryptocurrency portfolio. They want to create a precarious market situation by slowing down demand, but also be careful to avoid any chaos. Despite US GDP contracting for two consecutive quarters, the Fed is eager to assess and implement painful policies. Therefore, the cryptocurrency industry needs to find alternative methods to meet the challenge from the Federal Reserve.
The current market scenario demonstrates that crypto asset prices are intertwined with the stock and equity markets. Investors still view them as high-risk assets and are skeptical about investing during periods of high inflation. Therefore, it is imperative that the cryptocurrency sector distance itself from other traditional risk asset classes. Fortunately, a US central bank report suggests that risk perception towards cryptocurrencies is gradually changing.
According to a report by the Federal Reserve Bank of New York, cryptocurrencies are no longer in the top 10 most cited as potential risks to the US economy. This reveals a major shift in investor mindset, proving that cryptocurrencies will eventually become a risk-free asset class. But that won’t happen if cryptocurrencies continue to follow the legacy financial model. To beat inflation and offset Federal Reserve policies, the crypto industry must embrace decentralized finance for a strong future economy.
Bernd Stöckl is the co-founder and chief product officer of Palmswap, a decentralized perpetual contract trading protocol.
This article is for general information purposes and is not intended to be and should not be taken as legal or investment advice. The views, thoughts and opinions expressed herein are those of the author alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.
This post The Fed’s Pursuit of a “Reverse Wealth Effect” Is Undermining Crypto
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