The US Federal Reserve interest rate hike affects the market more than you think it would.
The Federal Reserve increased its interest rate by 75 basis points, which was contrary to the expected 50 basis points.
The US inflation rate currently runs at 8.58%, which is above the Fed's benchmark rate of 2%.
Stocks and interest rates have always had an inverse connection, suggesting that as interest rates rise, stock prices fall further
The hike has brought the volatility correlation between stocks and cryptocurrencies to its all-time peak, as the markets seem to be in tandem.
Many crypto market experts and investors consider traditional economic variables like inflation and interest rates to affect crypto value. For instance, a rise in the Fed interest rate might hike the demand for the dollar, thus a high demand for stablecoins, especially the dollar-backed ones. Alternatively, it could mean lower demand for volatile assets in the short term.
On 15th June 2022, the Federal Reserve increased its interest rate by 75 basis points, which was contrary to the expected 50 basis points. This was the highest hike since 1994. The Fed Reserve interest hike came at a time when the global market was experiencing record-high gas prices, crypto plunges, and dominated by a bear market, among others.
The Feds Strike
Jerome Powell, the Federal Reserve chairman, had earlier announced the impending increment of the Fed's interest rates to financial institutions. This was to curb the growing inflation rate that is currently at a 41-year high. The US inflation rate currently runs at 8.58%, which is above the Fed's benchmark rate of 2%.
The first interest rate hike came in March by 25 basis points, the first since 2018. The top cryptocurrency–Bitcoin– price briefly fell to trade 3% lower than the previous day before rebounding. This was followed by another 50 basis points rise in May.
The recent hike in June was contrary to the 50 basis point rise that Jerome Powell had announced. In fact, he expressed Fed's intention to raise the interest rates high enough to counteract the inflation. The hike brought the Federal's effective funds rate up to 1.75%.
“At the Fed, we understand the hardship high inflation is causing. We are strongly committed to bringing inflation back down, and we are moving expeditiously to do so." - Jerome Powell, Chair of the Federal Reserve
With four more FOMC (the committee that oversees interest rate modifications) meetings remaining, the global markets speculate four more interest rate hikes.
What the Hikes Mean for Cryptocurrencies
Stocks and interest rates have always had an inverse connection, suggesting that as interest rates rise, stock prices fall further. Increased interest rates lead to reduced consumer spending, which slows down economic activities. It also makes government securities more desirable, reducing the demand for stocks.
The hike also affected the crypto market, with Bitcoin currently trading at $20,294.59 from its ATH of $68,789.63. Ethereum has also dipped by nearly 78% from its all-time high.
While Bitcoin supporters argued that it was a hedge fund against inflation, the blue-chip coin seems to be in tandem with S&P 500. This brings the volatility correlation between stocks and digital assets to its all-time peak.
In a nutshell, higher interest rates mean that borrowing is more expensive, leading to a massive sell-off in riskier assets like crypto. Hence, just like stocks, the demand for cryptocurrencies falls as investors and hedge funds would be drawn to high-interest, low-risk bonds and savings accounts. When the demand for digital assets falls, the price naturally dips.
Crypto supporters are optimistic that the current high-rate environment is just a temporary situation, and that once inflation is curbed, the crypto market will see an upward trajectory.
The crypto community is closely watching the Fed's interest rate decisions this year. While a rate hike might cause short-term pain, it could ultimately be good for crypto's rapport. However, some worrying tail risks could make future declines much more severe.