Introduction

The key interest rate decisions of the Federal Reserve have a broad impact, affecting global markets, including cryptocurrencies such as Bitcoin. The cryptocurrency market is often seen as a hedge against traditional assets, showing dynamic responses to rate hikes and cuts. When the Federal Reserve adjusts its monetary policy, it can trigger a chain reaction in the demand, volatility, and liquidity of cryptocurrencies, which investors need to closely monitor.

How Interest Rates Affect Cryptocurrencies

The impact of rate hikes and cuts on the cryptocurrency market varies, depending mainly on investor sentiment and the broader economic environment. Rate cuts tend to bring optimism because they increase market liquidity, encourage more risky investments, and boost demand for speculative assets like Bitcoin. Conversely, rate hikes usually reduce market liquidity, making high-risk assets less attractive. Let's take a closer look at these two scenarios—rate hikes and cuts—and their different effects on the cryptocurrency market.

Advertisement

What Happens During Rate Cuts?

Bitcoin Price Increase After 2020 Rate Cut

Central bank or Federal Reserve rate cut decisions are usually a sign of economic weakness. When the Federal Reserve cuts rates, borrowing costs decrease, which often encourages high-risk investments, including cryptocurrencies.

Historical data shows that when the Federal Reserve cut rates by 0.25% in 2020, Bitcoin initially experienced a 60% correction, followed by an astonishing 1600% increase that year. Lower interest rates tend to shift investors away from traditional savings instruments towards more speculative assets, such as cryptocurrencies. Especially when inflation concerns occur alongside falling interest rates, the appeal of Bitcoin as a safe-haven asset significantly increases.A research report from S&P Global supports this viewpoint and highlights the significant correlation between Bitcoin price volatility and adjustments in monetary policy. Indeed, periods of low interest rates are typically accompanied by an increase in Bitcoin prices, while rapid interest rate hikes lead to price declines, reflecting broader market trends.

Why do interest rate hikes lead to a decline in cryptocurrencies?

Bitcoin price drop following interest rate hikes in 2022

On the other hand, interest rate hikes have the opposite effect. As Cointelegraph points out, interest rate hikes compress liquidity in the financial markets, reducing the appeal of high-risk assets such as cryptocurrencies. Interest rate hikes increase the returns on low-risk fixed-income instruments, prompting investors to withdraw funds from more volatile assets like Bitcoin.

Cryptocurrencies react to reduced liquidity in a similar manner to other risk assets: when the Federal Reserve announced its intention to raise interest rates in November 2021, cryptocurrencies fell, and the market continued to decline following the significant rate hikes by the Federal Reserve in 2022. Additionally, the collapse of cryptocurrencies like LUNA/UST and the bankruptcy of exchanges such as FTX further undermined traders' confidence in these virtual assets. At that time, the price of Bitcoin dropped by approximately 65%.

Currently, the market is in a consolidation phase due to the uncertainty surrounding the pace of interest rate cuts and the state of the U.S. economy.

Bitcoin's price is fluctuating based on market expectations: when the market anticipates interest rate hikes, Bitcoin prices fall; and when the Federal Reserve stops hiking rates, the market begins to digest expectations of rate cuts, causing Bitcoin prices to rise.

The market is currently in a consolidation phase because the pace of interest rate cuts and the state of the U.S. economy are not yet entirely clear. However, as the Federal Reserve begins to ease monetary policy after a period of tightening, it seems inevitable that Bitcoin prices will rise. Nevertheless, in the short term, Bitcoin may still enter a correction phase.

Thus, when the market anticipates an economic improvement, risk asset classes such as stocks and cryptocurrencies are also expected to rise together, driven by positive investor sentiment and increased liquidity. However, when interest rate hikes are primarily due to the Federal Reserve's tightening monetary policy to combat inflation, the cost of capital increases, reducing the appeal of risk assets like Bitcoin, and their value will decline as interest rates continue to rise.Other Factors

U.S. Treasury Bonds

Cryptocurrencies are often touted as a panacea for all problems, whether it be inflation, low interest rates, insufficient purchasing power, or the devaluation of the dollar. These positive factors are easy to believe in, and cryptocurrencies seem to grow independently of other assets.

It is interesting to observe the correlation between Bitcoin prices and the yield spread between the 10-year U.S. Treasury bond and the 2-year U.S. Treasury bond yield curve. The difference between these assets leads to corresponding adjustments in Bitcoin prices.

As far as we know, when the yield on short-term U.S. bonds is higher than that on long-term bonds, this is referred to as a yield curve inversion. Under normal circumstances, long-term bonds have higher yields because investors are more focused on riskier assets in the short term, such as Bitcoin, 2-year bonds, stocks, etc. However, when the yield curve inverts, meaning the yield on short-term bonds is higher than on long-term bonds, this indicates that investors are uneasy about economic conditions and may exit risk assets, including Bitcoin.

Conversely, when the yield on long-term bonds is higher than that on short-term bonds (which we are seeing now), it sends a positive signal for risk instruments like cryptocurrencies.

Differences Between U.S. Treasury Bonds and Bitcoin

A closer look reveals that Bitcoin's volatility also lags behind the yield curve spread (diverges). Further synchronization of these assets, coupled with a decrease in inflation rates and corresponding interest rate reductions, may bring hope for medium to long-term growth in Bitcoin.Institutional Investors Buying Bitcoin

The interest of institutional investors in Bitcoin has surged, with hedge funds and asset management companies viewing it as a tool to hedge against the devaluation of fiat currencies and an important diversification instrument. As institutional investors seek regulated investment opportunities, the growing demand for Bitcoin ETFs highlights this trend. According to Reuters, this institutional support is expected to support the price stability and future growth of Bitcoin, thereby driving potential bull market rallies. The influx of institutional capital is crucial for the market growth of Bitcoin, helping to maintain high price levels and providing long-term confidence in the value of the asset.

This indicates that while Bitcoin does respond to changes in the federal funds rate, it does not do so in isolation. The impact of interest rates must be viewed from a broader perspective of market conditions, institutional interests, and regulatory changes.

Macroeconomic Factors

China recently launched a massive stimulus plan, including lowering interest and mortgage rates, releasing liquidity, and committing over $100 billion to support the stock market. This comprehensive move could have a significant impact on global markets, boosting riskier, liquidity-sensitive asset classes such as stocks, gold, and Bitcoin. Analysts believe that if successful, it could also drive up inflation rates, which have been hovering just above zero. This move, which deviates from China's usual gradual approach, marks a significant shift in its economic strategy, and its global ripple effects will be closely monitored.

Bitcoin as a Hedge Against Inflation

Bitcoin's fixed supply of 21 million units makes it a powerful hedge against inflation. Unlike fiat currencies that governments can print, the scarcity of Bitcoin ensures that its value is not affected by inflationary pressures. This became evident in 2021 when U.S. inflation rates soared to 7%, and Bitcoin appreciated by over 300%, serving as a safeguard against currency devaluation.

Bitcoin shares common characteristics with gold and is often referred to as "digital gold" because both seem to act as stores of value during periods of high inflation. Bitcoin's decentralized nature ensures that it is not influenced by government monetary policies that often trigger inflation.Three Waves of Inflation in the 1970s

Looking at the historical trend of the 1970s, inflation developed in three waves, and experts believe that history may repeat itself. This could lead to further increases in Bitcoin, similar to the rise of gold during inflationary periods.

Inverse Correlation Between Bitcoin and the US Dollar Index

The inverse correlation between Bitcoin and the US dollar is also crucial. When the dollar weakens, Bitcoin tends to strengthen, making it an attractive alternative. This inverse correlation is very similar to that between gold and the US dollar, indicating that Bitcoin may continue to act as a hedge against fluctuations in fiat currency.

Although short-term cryptocurrency market volatility is influenced by Federal Reserve interest rate policies, the medium to long-term outlook for Bitcoin is positive, as it can offset inflationary costs and maintain its value as a safe investment. This characteristic makes it attractive to those who wish to preserve purchasing power during economically uncertain times.

Medium-Term Impact on Cryptocurrencies

Based on the above fundamental analysis and focusing on technical data on the charts, we can observe the following: in the medium term, looking at the daily chart, Bitcoin has been fluctuating within a descending channel since March 2024.

The current price faces significant resistance in the golden Fibonacci area. If it breaks through the upper boundary of the channel, it may send a bullish signal for the cryptocurrency market and potentially return to its historical high of 73,500 (ATH). However, if a correction scenario occurs, the price may fall to the support level of 58,500, aligning with the 38.2% Fibonacci ratio.

Long-Term Impact on CryptocurrenciesIn 2024, analysts from Standard Chartered Bank have repeatedly published predictions on the trend of Bitcoin exchange rates. In April of this year, they hypothesized that the price of BTC would grow to $150,000 by the end of the year.

Experts from the brokerage firm Bernstein also believe that by the end of the fourth quarter, the quote for the main cryptocurrency will break through the historical highest level of $80,000-90,000.

In addition, Anthony Scaramucci, the founder of the hedge fund SkyBridge Capital, stated that by the end of this year, the price of Bitcoin could reach a record $100,000.

This coincides with the predictions made by FBS analysts based on the technical analysis of the weekly Bitcoin chart. The $100,000 level corresponds to the 161.8 Fibonacci level when the cup-and-handle pattern breaks out. However, the potential correction trend may first reach the $50,000 area before rising to a new all-time high (ATH).

Conclusion

Changes in US interest rates, especially rate cuts, often drive Bitcoin and the broader cryptocurrency market, as lower rates encourage risk-taking investments. Historical data indicates that Bitcoin usually rebounds after rate cuts, driven by investors' interest in speculative assets and concerns about inflation. Although rate hikes can tighten liquidity and lead to price drops, Bitcoin's long-term potential remains strong, with analysts expecting significant gains by the end of 2024. As a tool against inflation and a speculative asset, the future of Bitcoin largely depends on broader economic trends and the policies of the Federal Reserve.