Expected Fed rate cut will support BTC price rally, but there is a problem

Photo of author

By journalsofus.com


The minutes of the December meeting of the Federal Reserve (Fed) released on Wednesday showed that there is a possibility of a cut in interest rates in 2024.

The long-awaited liquidity easing has been widely publicized as a significant bullish tailwind for Bitcoin (BTC), along with the impending spot ETF launch and the quadrennial mining reward halving of the Bitcoin blockchain.

there is a catch. Past data from MacroMicro shows that the early stages of a so-called stimulative Fed rate cut cycle often leave the economy on the brink of recession and lead to a brief but notable rally in the US dollar, the world’s largest global reserve currency. The most liquid government bond market.

In other words, if history is a guide, Bitcoin could see a brief and intense period of risk aversion later this year after the Fed begins cutting the benchmark federal funds rate.

A recession is a prolonged period of decline in economic output and increase in unemployment. Left to market forces, a recession can lead to a sharp decline in investors’ risk appetite and a decline in asset prices. Thus, central banks often counter this with monetary stimulus.

The dollar is a global reserve currency, which plays a major role in global trade, international credit and non-bank lending. When the greenback appreciates, dollar borrowers face higher loan repayment costs. This tightens financial conditions, causing investors to reduce investments in riskier assets like Bitcoin.

The dollar index, which gauges the exchange rate of the USD against major fiat currencies, initially strengthened after the Fed initiated rate-cutting cycles in mid-2000, September 2007 and August 2019. The S&P 500 is a proxy for the risk appetite of investors around the world. Risk aversion was observed during the early stages of the rate-cutting cycle.

The shaded area shows that the recession occurred after the Fed’s decision to cut rates.

Historically, the Fed has resorted to rate cuts only when a recession was on the doorstep. Due to this, forward-looking markets have started considering rate cuts as a harbinger of bad news and are seeking safety in the US dollar.

According to data tracked by investment banking firm Piper Sandler, recessions have been followed by successive recession cycles over the past 60 years.

“This sequence often occurs as the Fed tries to raise and maintain high-interest rates longer than necessary, thereby inadvertently stifling economic growth. Rate cuts are typically implemented only when the economy is clearly in trouble.” By that point, a recession is usually inevitable,” Piper Sandler said in a note to clients on Jan. 2.

“This time, it’s likely the same pattern will be repeated, with the Fed maintaining a dovish stance longer than necessary,” Piper Sandler said.

According to some observers, markets are currently overestimating the ability of the US economy to avoid a recession in the wake of the Fed rate hike cycle, which has seen borrowing costs rise 525 basis points to 5.25% in the 16 months to July 2022 . Negative market reaction to a potential recession.

Leave a comment