Markets tend to make assumptions about the future. In the cases of the crypto, stock, and bond markets, a recent assumption has been that the US Federal Reserve is not only done raising interest rates but also that they will be lowering them at least three times in 2024. The Federal Reserve chairman has been very clear that the Fed’s actions will be based on data and that rate reductions will only occur when and if inflation keeps getting better. Because inflation has been more “sticky” than many anticipated, the Fed is not lowering rates and has even suggested the possibility of another rate increase this year. Bitcoin has been going up and one of the drivers of its price has been the assumption that rate decreases are coming this year. What happens to Bitcoin if interest rates go up instead of down in 2024?
Interest Rates and the US Federal Reserve
The United States Federal Reserve is America’s central bank. The Fed has two mandates from Congress. The first is to maintain price stability and the other is to maximize employment. They do this by raising and lowering interest rates, buying or selling bonds, and attempting to increase or decrease the availability of credit. Inflation or steadily higher prices for goods and services is what the Fed routinely has to deal with. In 2021 US inflation started going up and it peaked at 9.1% in June of 2022. The Fed countered by raising interest rates from near zero to 5% in steps of a quarter or half point almost every month. Their goal is a 2% rate of inflation and continued strong employment. So, how are they doing?
Fed Progress With Inflation and Interest Rates
Higher interest rates are serving their purpose and bringing interest rates down. That being the case, the Fed has not raised rates for months and spoke about the potential for three rate decreases later this year. Because inflation is stuck in the 3% range the Fed has to decide whether to simply wait or increase rates another time or two. Throughout all of this they are doing great on the employment mandate as US employment is its strongest in more than 50 years. Thus the employment situation is not going to require the Fed to cut rates any time soon.
How the Fed and Interest Rates Affect Markets
At the end of 2021 the markets saw rates increases on the horizon. The S&P 500 stock index fell by 23% by September 2022 and Bitcoin fell 74%! Looking forward, the stock market typically expects higher interest rates to hurt business and increase unemployment. Bitcoin, which many believed was immune to this dynamic, was not. Crypto winter helped usher in a period of crypto business bankruptcies. If the Fed does raise rates again this year we may well see a similar reaction from the markets. However, it should not be nearly as severe if the market realizes that the Fed would only raise rates a quarter or half a percent. However, markets are not always rational. One needs to look at the current sentiment of a market as a starting point before considering how an external forces might drive it up or down. In the case of Bitcoin and the crypto market in general the introduction of spot Bitcoin ETFs has been a stimulus to Bitcoin trading and prices. Add to this the expectation of steadily lower interest rates and more naïve Bitcoin investors and traders may well have come to believe that the bad old days of crypto winter are long gone and Bitcoin will go up forever. If and when the Fed raises rates again it will test the strength of this resurgent belief. Traders and investors who have been betting everything on a Bitcoin resurgence may well panic at the belief that crypto winter is returning. If that turns out to be the case, what happens when interest rates go up is that Bitcoin crashes, at least in the near term, once again taking people’s money with it.