In early November of 2021, the Federal Reserve said it would begin tapering its asset purchases. The marketplace took these comments to reduce monetary accommodation and help reduce rising inflation expectations. The initial move by the Federal Reserve was to purchase 10 billion less in U.S. Treasury securities and five billion less in Mortgage Back securities.
While this was only the beginning of what morphed into a more hawkish monetary policy during the balance of 2021 and January of 2022, the Fed’s comments started a correction in the online trading of Bitcoin. The question for investors is where Bitcoin can rally under the pressure of the Fed’s new monetary policy.
How Has The Fed’s Policy Changed?
The Federal Reserve during the pandemic had been very accommodative. Short-term borrowing rates remained near zero, and the Fed continues to purchase bonds to keep interest rates low. The Fed meeting minutes for December show that the Open Market Committee, which determines short-term bank borrowing interest rates for the United States, changed its outlook on where they see interest rates, inflation, and growth.
One of the key changes was their realization that inflation was no longer transitory and needed to be dealt with immediately. Members of the Board of Governors of the Federal Reserve changed their “dot plots,” which shows where they see interest rates moving in the months and years to come.
The Fed projected the path to higher interest rates, which now sees on average rates moving higher by 75 basis points during 2022. Their move was not a surprise, as the market had already priced these numbers into the rates of Treasury Securities. In fact, as of mid-January 2022, the markets had priced in 100 basis points of rate hikes during 2022.
The December Fed minutes also showed that the committee was concerned about inflation and that the U.S. jobs market was nearing full employment. Nearly all of the Fed Open Market Committee agreed that it would be appropriate to let their balance sheet runoff and decline as inflation was accelerating.
The opinion of members had changed. They now believe that the appropriate ultra-accommodative monetary policy during the pandemic was no longer warranted. The question is whether the Fed had made policy mistakes by waiting so long to alter their view on interest rates.
What Hurdles are the Fed Facing?
The Fed has a dual mandate. They need to maximize employment while keeping price stability. While lockdowns occurred across the United States during the pandemic’s beginning, the unemployment rate surged, and inflation tumbled. Fast forward two years and the combination of accommodative policy and supply chain disruption has accelerated consumer inflation. In December 2021, the U.S. CPI hit a 50 year high of 7% year over year.
Additionally, wage inflation had surged, and unemployment has dropped to a pre-pandemic low below 4%. The Fed faces a very tight U.S. job market, rising inflation, and online trading that reflects rising bond yields. The market is telling the Fed that they believe rates should be higher and might be behind the curve.
How Does This Impact Bitcoin?
The rally in U.S. Treasury Yields has helped buoy the U.S. dollar and capped the upward trajectory of riskier assets and other ways to store value. Bitcoin is quoted in many currencies, but the most widely traded pair is Bitcoin versus the U.S. dollar.
The interest rate differential between Bitcoin rates and U.S Treasury rates has moved in favor of the U.S. dollar since the Fed announced that they were planning to unwind their accommodative policy in November. The new Fed policy has also eroded the store of value that Bitcoin has held, and consequently, the exchange rate has sold off.
Can Bitcoin Rally in the Face of Higher U.S. Interest Rates?
The Fed is now on a course to increase rates. The market’s take on these changes is that the Fed will need to reduce inflation expectations quickly. Markets do not like quick policy changes. This dislike has been reflected in a sell-off in equities and a sell-off in Bitcoin.
Once the fear of inflation starts to decelerate, the markets will begin to price in fewer changes to short-term borrowing rates, which could allow Bitcoin to gain a toe hold. The markets have already done a lot of the heavy lifting for the Fed. The 10 year Treasury yield, the benchmark for home lending, is now back to pre-pandemic levels.
Online trading rates at these levels will reduce lending and cap inflation for shelter. Any slowdown in inflation in conjunction with slower growth and declines in jobs data could allow rates to moderate and help Bitcoin gain traction.
The upshot is that if the markets believe the Fed is behind the curve and will need to accelerate tightening, it will be difficult for Bitcoin to rise. On the other hand, if the market believes that the Fed has caught up and inflation has moderated, Bitcoin may end up rising.