Struggling to find a suitable explanation for the market crash, he seeks advice from an experienced trading buddy (let's call him Abdul). After a quick exchange, Mike learns that the Federal Reserve announced a 25 basis point rate hike and the market didn't seem to like that news.
There are many stories similar to this one. Let's help Mike by discussing how a rate hike by the Fed will affect the crypto market.
Join us as we introduce you to the cryptocurrency revolution, one newsletter at a time. Subscribe now to receive daily news and market updates straight to your inbox. And along with millions of other subscribers (yes, millions of subscribers love us!), what are you waiting for?
Maximizing employment: The Fed strives to create the highest levels of sustainable employment, considering factors such as employment growth, labor force participation, and unemployment rates. By adjusting monetary policy, the Fed can foster an economic environment that fosters job creation and labor market stability.
Price stability: Controlling inflation is essential to increasing economic certainty, preserving the real value of money, and promoting long-term economic growth. As part of its price stability mission, the Fed targets an inflation rate of 2% over the long term.
Moderate long-term interest rates: Maintaining moderate long-term interest rates can generate sustainable economic growth and investment. By influencing short-term interest rates such as the federal funds rate, the Federal Reserve can indirectly influence long-term interest rates and contribute to a stable and healthy financial environment.
What is monetary policy?
Monetary policy is created by a country's central bank with the purpose of controlling the supply of money into the economy and achieving the main objectives we just discussed: maximum employment, low and stable inflation, and moderate interest rates. It's a set of rules.
Central banks can change monetary policy to combat inflation and price increases, create new jobs, or cushion the effects of recessions. In that sense, monetary policy can be seen as a toolbox for central banks to guide the economy in a desired direction.
The best-known tools of monetary policy are quantitative easing, open market operations, interest rate changes, and reserve requirements, but central banks have many more tools at their disposal.
At the meeting, FOMC members consider economic conditions and its potential risks and discuss whether the situation requires a change in monetary policy. A notable example of this occurred after the onset of the pandemic, when the Federal Reserve resorted to injecting capital into the economy at an unprecedented rate. Although this addressed the problem in the short term, it also came with negative side effects. Inflation spiked significantly, reaching 9.1% year-on-year inflation in June 2022.
The FOMC has since been working to bring back inflation by raising interest rates, which could impact employment and cause an economic downturn. As you know, the FOMC's job is not easy.
Interest rates are rising again! When we talk about rising interest rates, we are referring to rising interest rates. federal funds ratethe interest rate at which commercial banks can lend and borrow money from each other overnight. The federal funds rate is the range of interest rates that banks can use to borrow or make loans.
With inflation spiraling out of control, the FOMC decided to raise interest rates nine times, pushing interest rates from 0.25% to 5% in just over a year.
As of this writing, the federal funds rate is between 4.75% and 5.00%.
When the federal funds rate increases, the cost of capital increases. This increases borrowing costs for banks and causes them to charge higher interest rates to their customers. Mortgages become more expensive, and commercial loans and credit card debt costs rise as well. In other words, by raising interest rates, the Fed makes investment and spending more expensive, which causes the demand curve to fall.
If you've studied economics, you know that a decrease in demand usually leads to a decrease in price. Reducing prices (and thus inflation) by raising interest rates is like using a fire extinguisher.
Changes in the federal funds rate not only combat inflation, but their effects can extend throughout the economy and even into financial markets. The stock market is known to be sensitive to changes in the federal funds rate. For example, when the Fed lowers interest rates, stock markets typically rise because business costs fall and public companies become more profitable.
In contrast, rising interest rates typically push down stock prices by increasing business costs and reducing profits. Since there is a correlation between the stock market and cryptocurrencies, a bearish reaction in the stock market will also lead to a decline in the token.
Nevertheless, the biggest short-term impact of rate hikes is psychological. Markets are good at pricing in information and often move in anticipation of FOMC decisions. For example, on March 22, the market rose on expectations for a pause in rate hikes. When the FED recently announced a 25 basis point interest rate hike, it caused a 7.9% correction in Bitcoin price.
The announcement of a 25 basis point rate hike at the start of this rate hike cycle came as a surprise, resulting in a significant sell-off. Now that we have survived nine consecutive interest rate hikes, the effects of new rate hike decisions are starting to wane somewhat. Although still causing considerable volatility, the market has generally been very effective in pulling back on corrections, returning the market to pre-rate hike announcement levels. The market is getting used to interest rate hikes.
Overall, it is clear that the Fed has strong influence over financial markets. Their quantitative easing program pushed asset prices to all-time highs in 2021, and their interest rate hike decisions have pushed prices down over the past year.
At this point, the market has become accustomed to interest rate hikes, and the short-term impact on prices has diminished. It is very difficult to predict interest rate decisions and even more difficult to predict the impact of those decisions on the market. Nevertheless, it is helpful to have a basic understanding of the driving forces behind the economy. It also helps you understand why the market moves the way it does.
Writer's Disclaimer: This article is based on my limited knowledge and experience. This is written for educational purposes. It should not be construed as advice in any way. Please find out for yourself.
This article contains links to third party websites or other content (“Third Party Sites”) for informational purposes only. Third Party Sites are not under the control of CoinMarketCap, and CoinMarketCap is not responsible for the content of Third Party Sites, including without limitation any links contained in Third Party Sites, or any changes or updates to Third Party Sites. We are not responsible for party site. CoinMarketCap is providing these links to you only as a convenience, and the inclusion of any link does not imply endorsement, endorsement, or recommendation by CoinMarketCap of the site or any association with its operators. This article is intended for use and should be used for informational purposes only. It is important that you conduct your own independent research and analysis before making any important decisions related to the products or services mentioned. This article is not intended to be, and should not be construed as, financial advice. The views and opinions expressed in this article are those of the author. [company’s] are proprietary and do not necessarily reflect those of CoinMarketCap. CoinMarketCap is not responsible for the success or reliability of any project. We aim to act as a neutral information resource for end users.
