The Federal Reserve is preparing to embark on its largest rate hike in decades in an effort to tame inflation, but what effect will this have on bitcoin (BTC-USD) and other cryptocurrencies?
Cryptoassets continue to exhibit a strong correlation with equities and traders anticipate bitcoin and other major cryptocurrencies will react with a bearish movement if a hawkish approach to interest rates is decided upon at the Fed's monetary policy meeting on Wednesday.
Fiscal hawks have watched the expansion of the money supply and the subsequent rise in inflation with growing concern and are generally in favour of relatively higher interest rates.
The rate of inflation in the US is 8.5% for the 12 months ending March 2022. This is the highest since December 1981 and has reinforced the argument that a sharp rate hike is needed to keep inflation in check.
CEO of the Federal Reserve Bank of St. Louis James Brian Bullard has even warned that a 75 basis point rate hike should not be ruled out as the US central bank tries to slow the US economy enough to control inflation, but not enough that it teeters into a recession.
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However, others warn that a substantial rate hike at this fragile moment would tilt the US economy into recession and further dampen economic growth as the nation emerges from the distress caused by the coronavirus pandemic.
This is a view held by former Federal Reserve vice-chair Roger Ferguson who reacted to the rate hike anticipation by declaring on CNBC that "a recession at this stage is almost inevitable".
Speaking to Yahoo Finance about the effects of a rate hike on the crypto-ecosystem, Nicholas Cawley, strategist at DailyFX, said the effect would be minimal. "It is very unlikely that a neutral Fed outcome of a 50 basis point rate hike will have any noticeable effect on the cryptocurrency market," he said.
However, he added: "What may increase volatility is the post-decision press conference where Fed chair Jerome Powell will add some further detail about voting details and the recently announced quantitative tightening program.
"If Powell reveals any voting members made a case for a 75 basis point rise at this meeting, or if he suggests that, data dependant, that this may happen in the future, then the market would see this as a hawkish twist and risk-on asset markets, including cryptos, would likely come under renewed selling pressure.
"I think historically yes based on my feeling as someone that wants to buy Bitcoin. Fed says USD dollar is not going to be affected. It's worth more. So I want to put it to work and Bitcoin seems to be the best bet in the long term."
If there are signals of a potential 75 basis point rise, Mark Basa, the director at HOKK Finance, said bitcoin may react negatively, "but again historically when we think it's going to dump, there's a green Monday".
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Basa said that bitcoin whales would take advantage of the Fed's motions towards interest and the dollar, "and buy the dip almost regardless of the price".
The world's preeminent cryptocurrency still remains heavily correlated to traditional markets, and according to Goldman Sachs (GS), bitcoin moves in lockstep with the stock market.
“Prior to the pandemic, bitcoin and other digital assets showed low correlations to traditional financial market variables, in effect, crypto behaved as an entirely different ecosystem," Zach Pandl, co-head of foreign exchange strategy at Goldman Sachs told the Financial Times in early 2022.
“But over the last two years, as bitcoin has seen wider mainstream adoption, its correlation with macro assets has picked up.”
There seems to be a trend of a tightening link between cryptocurrencies and mainstream financial assets which could be the result of more professional traders entering the digital finance sphere.
Bitcoin's mirroring of the sharp fluctuations of traditional markets is at odds with its promise of becoming an immutable and decentralised hedge against the institutional financial system.
Joe Morgan of Bitfinix said: "A ramp-up in Fed interest rates has been well-telegraphed in the bond market and is largely in the price of most risk assets.
"Bitcoin has been viewed more recently as belonging to the same category, however, its longer-term valuation is also underpinned by its scarcity and its potential to offer a fast and cheap peer-to-peer payments platform."