The US Federal Reserve has begun the process of lowering interest rates now that inflation has fallen near to their 2% target and there is evidence that higher rates have begun to affect the levels of employment and unemployment. Crypto winter was largely caused by the prospect of and subsequent reality of substantially higher interest rates that we had seen for years. Although crypto, and especially Bitcoin and Ether, have recovered significantly, there is always more room for further gains. So, will lower interest rates drive crypto higher?
How Much Will the Fed Cut Interest Rates?
As always happens when the US Federal Reserve is likely to raise or lower interest rates, market speculation is intense. Likewise, potentially affected assets typically spike up and down as traders place their bets. Our concern at this point is not the short term ups and downs of assets like Bitcoin, but rather their pricing three, six, and twelve months from now in a world of substantially lower interest rates. Billionaire investor John Paulson recently weighed in on the subject of interest rates by the end of 2025 as reported by Bloomberg. His prediction was the Fed will cut their interest rate to 3% or as low as 2.5% with a series of small rate reductions until the end of 2025. If this is to be the case, where will Bitcoin, Either and the rest of crypto be by then?
Last Six Months Bitcoin Price Courtesy of Google Finance
How Do Crypto Prices Relate to Interest Rates?
When the Fed began raising rates to quell inflation the entire crypto world, with the exception of dollar-backed stablecoins, reacted like the stock market and prices plummeted. As markets began to expect rate cuts both the stock market and crypto prices have recovered and even gone to new highs. Is there a longer term association between interest rates and cryptocurrency prices? It goes against the old mantra that cryptocurrencies are a world apart from the traditional financial system to believe that crypto prices are responsive to the interest rates that work their way across dollar, yen, and euro-based economies. Nevertheless, as noted by Forbes, Bitcoin prices may well rise when the Fed lowers rates.
As a rule, speculators are more prone to trade or invest short term in risky assets when the economy is strong and interest rates are low and they tend to avoid those risky assets when rates go up and the risk of a recession increases. Forbes notes that this dynamic often affects the crypto market. However, other factors that have the potential to drive crypto prices, and especially Bitcoin prices, include adoption of Bitcoin or their own digital currency by nation states. The addition of Bitcoin and Ether ETFs to the picture, failures of large crypto exchanges, and supply-demand issues like the next Bitcoin halving.
Thus, interest rates have an effect on crypto but are not the only factor that drives prices.
Interest Rates and Bitcoin As a Store of Value
One of the arguments for holding Bitcoin long term has always been that it is a store of value that is superior to the dollar, the euro or the yen. The rationale is that we already know the eventual total number of Bitcoin that will be in existence and we are nearly to that goal already. This is unlike the situation with national currencies, which can be printed when a country needs more money or, today, created with a keystroke by the head of a nation’s central bank. Thus, Bitcoin will never experience the kind of rampant inflation that destroyed the German Weimar Republic and ushered in Hitler’s National Socialists and has destroyed the economies of previously prosperous nations like Venezuela. The threat of the USA dealing with its national debt by devaluing its currency via steady inflation drives some to hoard gold or buy and hold Bitcoin. To the extent that the US has continually lower interest rates than make sense economically, the argument for holding gold or Bitcoin makes perfect sense. To the extent that, as Chair Power notes, we are likely to see somewhat higher interest rates for much longer in the future, there is an argument for merely buying and selling cryptocurrencies and as the market rises and falls and holding the profit in stablecoins or currencies like the dollar, yen, or euro.